-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, G/OC+ELKVqS0Pi36pN4lZRNm3pFv1PU4BzFwD7UEMxn0ICyTsPaeSb15KtOy7AK/ 5qU7hqcHFIWuV1xwfv3vxA== 0000928385-02-002449.txt : 20020628 0000928385-02-002449.hdr.sgml : 20020628 20020628154937 ACCESSION NUMBER: 0000928385-02-002449 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 15 FILED AS OF DATE: 20020628 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CITIZENS SOUTH BANKING CORP CENTRAL INDEX KEY: 0001051871 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 562063438 STATE OF INCORPORATION: SC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1 SEC ACT: 1933 Act SEC FILE NUMBER: 333-91498 FILM NUMBER: 02691498 BUSINESS ADDRESS: STREET 1: 245 WEST MAIN STREET CITY: GASTONIA STATE: NC ZIP: 28053 BUSINESS PHONE: 7048685200 MAIL ADDRESS: STREET 1: 245 WEST MAIN STREET CITY: GASTONIA STATE: NC ZIP: 28053 FORMER COMPANY: FORMER CONFORMED NAME: GASTON FEDERAL BANCORP INC DATE OF NAME CHANGE: 19971222 S-1 1 ds1.txt FORM S-1 As filed with the Securities and Exchange Commission on June 28, 2002 Registration No. 333-________ ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 CITIZENS SOUTH BANKING CORPORATION (Name of Small Business Issuer in Its Charter) Delaware 6712 (Applied For) (State or Jurisdiction of (Primary Standard Industrial (I.R.S. Employer Incorporation or Organization) Classification Code Number) Identification No.)
245 West Main Avenue Gastonia, North Carolina 28053 (704) 868-5200 (Address and Telephone Number of Principal Executive Offices) 245 West Main Avenue Gastonia, North Carolina 28053 (704) 868-5200 (Address of Principal Place of Business or Intended Principal Place of Business) Kim S. Price 245 West Main Avenue Gastonia, North Carolina 28053 (704) 868-5200 (Name, Address and Telephone Number of Agent for Service) Copies to: John J. Gorman, Esq. Robert B. Pomerenk, Esq. Luse Gorman Pomerenk & Schick, P.C. 5335 Wisconsin Avenue, N.W., Suite 400 Washington, D.C. 20015 Approximate date of proposed sale to the public: As soon as practicable after this registration statement becomes effective. If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 of the Securities Act of 1933, check the following box: [X] If this Form is filed to register additional shares for an offering pursuant to Rule 462(b) under the Securities Act please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering: [ ] If the delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box: [ ] CALCULATION OF REGISTRATION FEE
========================================================================================================================= Proposed maximum Proposed maximum Amount of Title of each class of Amount to be offering price aggregate registration fee securities to be registered registered per share offering price(1) - ------------------------------------------------------------------------------------------------------------------------- Common Stock, $0.01 par value per share 9,063,021 shares $ 10.00 $ 90,630,210 $ 8,338 - ------------------------------------------------------------------------------------------------------------------------- Participation Interests 350,000 interests -- -- -- =========================================================================================================================
(1) Estimated solely for the purpose of calculating the registration fee. (2) The securities of Citizens South Banking Corporation to be purchased by the Citizens South Bank Employees' Savings & Profit Sharing Plan as adopted by Citizens South Bank are included in the amount shown for Common Stock. However, pursuant to Rule 457(h) of the Securities Act of 1933, as amended, no separate fee is required for the participation interests. Pursuant to such rule, the amount being registered has been calculated on the basis of the number of shares of Common Stock that may be purchased with the current assets of such Plan. The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine. Prospectus Supplement --------------------- Interests in CITIZENS SOUTH BANK Employees' Savings & Profit Sharing Plan and Offering of 350,000 Shares of CITIZENS SOUTH BANKING CORPORATION Common Stock Citizens South Banking Corporation is providing this prospectus supplement to participants in the Citizens South Bank Employees' Savings & Profit Sharing Plan (the "Plan"). As a participant in this Plan, you may direct the trustee of the Plan to purchase common stock of Citizens South Banking Corporation in its common stock offering, with amounts currently allocated to your account under the Plan. If you cannot acquire all the common stock you want in the offering due to an oversubscription, the trustee will apply the amounts which were not used to acquire commons stock among the funds in which your Plan account is invested in proportion to your current investment allocation percentages for new contributions. The prospectus of Citizens South Banking Corporation, dated August [ ], 2002, which is attached to this prospectus supplement, includes detailed information regarding the offering and the financial condition, results of operations and business of Citizens South Banking Corporation. You should read this prospectus supplement, which provides information with respect to the Plan, together with the prospectus. ____________________ For a discussion of risks that you should consider before making an investment decision, see "Risk Factors" beginning on page__ of the prospectus. The interests in the Plan and the offering of the common stock have not been approved or disapproved by the Office of Thrift Supervision, the Securities and Exchange Commission or any other Federal or state agency. Any representation to the contrary is a criminal offense. The securities offered in this prospectus supplement are not deposits or accounts and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other Government agency. An investment in the Employer Stock Fund is subject to loss. The date of this Prospectus Supplement is ______________, 2002. TABLE OF CONTENTS THE OFFERING ................................................................................. 1 Securities Offered ........................................................................ 1 Election to Purchase Common Stock in The Offering: ........................................ 1 Priorities ................................................................................ 1 Value of the Plan Assets .................................................................. 2 Method of Directing Transfer .............................................................. 2 Time for Directing Transfer ............................................................... 2 Irrevocability of Transfer Direction ...................................................... 3 Direction to Purchase Common Stock after the Offering ..................................... 3 Purchase Price of Common Stock ............................................................ 3 Nature of a Participant's Interest in the Common Stock .................................... 3 Voting Rights of Common Stock ............................................................. 3 DESCRIPTION OF THE PLAN ...................................................................... 4 Introduction .............................................................................. 4 Eligibility and Participation ............................................................. 4 Contributions Under the Plan .............................................................. 5 Limitations on Contributions .............................................................. 5 Benefits Under the Plan ................................................................... 6 Withdrawals and Distributions From the Plan ............................................... 6 Investment of Contributions and Account Balances .......................................... 7 Performance History ....................................................................... 8 Administration of the Plan ................................................................ 12 The Trustee ............................................................................... 12 Plan Administrator ........................................................................ 12 Reports to Plan Participants .............................................................. 12 Amendment and Termination ................................................................. 13 Merger, Consolidation or Transfer ......................................................... 13 Federal Income Tax Consequences ........................................................... 13 Additional Employee Retirement Income Security Act ("ERISA") Considerations ............... 14 Securities and Exchange Commission Reporting and Short-Swing Profit Liability ............. 15 Financial Information Regarding Plan Assets ............................................... 16 LEGAL OPINION ................................................................................ 16
THE OFFERING Securities Offered Citizens South Banking Corporation is offering participants in the Citizens South Bank Employees' Savings and Profit Sharing Plan (the "Plan") the opportunity to use their participation interests to elect to purchase shares of Citizens South Banking Corporation's common stock through the Plan. At May 31, 2002, there were sufficient funds in the Plan to purchase up to 350,000 shares of Citizens South Banking Corporation common stock in the offering. This includes the new shares of Citizens South Banking Corporation which may be received in exchange for all of the shares of Citizens South Banking Corporation common stock presently held in the Plan. The shares of common stock currently held in the Plan will be exchanged for shares of Citizens South Banking Corporation pursuant to an exchange ratio, as is more fully discussed in the "Conversion" section of the prospectus. Only employees of Citizens South Bank and it affiliates may become participants in the Plan. Your investment in the common stock of Citizens South Banking Corporation through the Plan in the offering is subject to the priorities listed below. Information with regard to the Plan is contained in this prospectus supplement and information with regard to the financial condition, results of operations and business of Citizens South Banking Corporation is contained in the attached prospectus. The address of the principal executive office of Citizens South Bank is 245 West Main Avenue, P.O. Box 2249, Gastonia, North Carolina 28053-2249. Election to Purchase In connection with the conversion and stock offering, Common Stock in the you may elect to transfer all or part of your account Offering: balances in the Plan (other than the amounts you Priorities currently have invested in the Employer Stock Fund) to the Employer Stock Fund, to be used to purchase common stock issued in the offering. The trustee of the Employer Stock Fund will purchase common stock in accordance with your directions. In the event the offering is oversubscribed, i.e. there are more orders for common stock than shares available for sale in the offering, and the trustee is unable to use the full amount allocated by you to purchase common stock in the offering, the amount that cannot be invested in common stock will be reinvested in the investment funds of the Plan in accordance with your then existing investment election (in proportion to your investment allocation percentages for new contributions). If you fail to direct the investment of your account balances towards the purchase of any shares in the offering, your account balances will remain in the investment funds of the Plan as previously directed by you. The shares of common stock are being offered in a subscription offering and community offering. In the subscription offering, the purchase priorities are as follows: (1) Depositors with $50 or more as of March 31, 2001, get first priority. (2) Citizens South Banking Corporation's tax- qualified plans, including the employee stock ownership plan and 401(k) plan, get second priority. (3) Depositors with $50 or more on deposit as of June 30, 2002 get third priority. (4) Depositors as of July 31, 2002 get fourth priority. To the extent you fall into one of these categories, you may use funds in your Plan account to pay for the common stock you want to acquire in the stock offering, at $10.00 per shares. Common stock so purchased will be placed in the Employer Stock Fund and allocated to your Plan account. Value of the Plan Assets As of May 31, 2002, the market value of the assets of the Plan was approximately $3.5 million. The plan administrator informed each participant of the value of his or her account balance under the Plan as of March 31, 2002. Method of Directing You will receive a special election form on which Transfer you can elect to transfer all or a portion of your account balance in the Plan to the Employer Stock Fund for the purchase of stock in the offering (other than amounts you currently have invested in such fund). If you wish to use all or part of your account balance in the Plan to purchase common stock issued in the offering (other than amounts you currently have invested in the Employer Stock Fund), you should indicate that decision on the investment allocation form. If you do not wish to purchase Citizens South Banking Corporation stock in the offering through the Plan, you need not complete the special election form. Time for Directing Transfer If you wish to purchase common stock with your Plan account balances, your special election form must be received by Pentegra Services, Inc., c/o Joan Wheeler, Consultant, Consulting Services, Pentegra Group, 108 Corporate Park Drive, White Plains, New York 10604-3805 no later than 12:00 p.m. on September ___, 2002. 2 Irrevocability of Transfer You may not revoke your special election to Direction transfer amounts credited to your account in the Plan to the Employer Stock Fund for the purchase of stock in the offering. You will, however, continue to have the ability to transfer amounts not directed towards the purchase of stock in the offering amongst all of the other investment funds, including the Employer Stock Fund, on a daily basis. Direction to Purchase Whether you choose to purchase stock in the Common Stock after the offering, or attempt to purchase stock in the Offering offering but are unable to do so because the offering is oversubscribed, you will also be able to purchase stock after the offering through your investment in the Employer Stock Fund. After the offering, you may direct that a certain percentage of your account balance in the Plan be transferred to the Employer Stock Fund and invested in common stock, or to the other investment funds available under the Plan. After the offering, you may change your investment allocation on a daily basis. Special restrictions may apply to transfers directed to and from the Employer Stock Fund by the participants who are subject to the provisions of section 16(b) of the Securities Exchange Act of 1934, as amended, relating to the purchase and sale of securities by officers, directors and principal shareholders of Citizens South Banking Corporation. Purchase Price of Common The trustee will use the funds transferred to the Stock Employer Stock Fund to purchase common stock in the offering, subject to your ability to purchase shares in accordance with the priorities listed on the second page of this prospectus supplement and, except in the event of an oversubscription, as discussed above. The trustee will pay $10.00 per share, which will be the same price paid by all other persons in the offering. No sales commission will be charged for shares purchased in the offering. After the offering, the trustee will acquire common stock in open market transactions at the prevailing price. The trustee will pay transaction fees, if any, associated with the purchase, sale or transfer of the common stock after the offering. Nature of a Participant's The trustee will hold the common stock, in trust, Interest in the Common for the participants of the Plan. Shares of common Stock stock acquired by the trustee at your direction will be allocated to your account. Therefore, investment decisions of other participants should not affect the earnings allocated to your account. Voting Rights of Common The trustee generally will exercise voting rights Stock attributable to all common stock held by the Employer Stock Fund. 3 DESCRIPTION OF THE PLAN Introduction Citizens South Bank (formerly Gaston Federal Bank) adopted a multiple-employer defined contribution plan (the "Financial Institutions Thrift Plan") effective January 1, 1993. Citizens South Bank withdrew from the Financial Institutions Thrift Plan and adopted a single-employer plan effective January 1, 1998, in order to permit the investment of Plan assets in common stock. The Plan is a tax-qualified plan with a cash or deferred compensation feature established in accordance with the requirements under Section 401(a) and Section 401(k) of the Internal Revenue Code of 1986, as amended (the "Code"). Citizens South Bank intends that the Plan, in operation, will comply with the requirements under Section 401(a) and Section 401(k) of the Code. Citizens South Bank will adopt any amendments to the Plan that may be necessary to ensure the continuing qualified status of the Plan under the Code and applicable Treasury Regulations. Employee Retirement Income Security Act. The Plan is an "individual account plan" other than a "money purchase pension plan" within the meaning of ERISA. As such, the Plan is subject to all of the provisions of Title I (Protection of Employee Benefit Rights) and Title II (Amendments to the Internal Revenue Code Relating to Retirement Plans) of ERISA, except to the funding requirements contained in Part 3 of Title I of ERISA which by their terms do not apply to an individual account plan (other than a money purchase plan). The Plan is not subject to Title IV (Plan Termination Insurance ) of ERISA. The funding requirements contained in Title IV of ERISA are not applicable to participants or beneficiaries under the Plan. Reference to Full Text of Plan. The following portions of this prospectus supplement summarize certain provisions of the Plan. They are not complete and are qualified in their entirety by the full text of the Plan. Words capitalized but not defined in the following discussion have the same meaning as set forth in the Plan. Copies of the Plan are available to all employees by filing a request with the Plan Administrator c/o Citizens South Bank, 245 West Main Avenue, P.O. Box 2249, Gastonia, North Carolina 28052-4140. Each employee is urged to read carefully the full text of the Plan. Eligibility and Participation An employee is eligible to participate in the Plan on the first day of the month following completion of three (3) months of employment during which he or she completes at least 250 hours of service with Citizens South Bank. The plan year is January 1 to December 31 (the "Plan Year"). As of June 25, 2002, there were approximately 88 employees eligible to participate in the Plan, and 82 employees participating by making elective deferral contributions. 4 Contributions Under the Plan 401(k) Plan Contributions. Each participant in the Plan is permitted to elect to defer his or her Plan Salary (as defined below) on a pre-tax basis up to 75% of annual Plan Salary (expressed in terms of whole percentages) and subject to certain other restrictions imposed by the Code, and to have that amount contributed to the Plan on his or her behalf. For purposes of the Plan, "Plan Salary" means, generally, a participant's regular, basic salary, plus commissions, overtime and bonuses. In 2002, the annual Plan Salary of each participant taken into account under the Plan is limited to $200,000. (Limits established by the IRS are subject to increase pursuant to an annual cost of living adjustment, as permitted by the Code). A participant may elect to modify the amount contributed to the Plan by filing a new elective deferral agreement with the Plan Administrator on a monthly basis. Employer Contributions. The Bank makes matching contributions to the Plan equal to 50% of the elective deferral contributions, with a maximum matching contribution of 3% of the participant's Plan Salary for the Plan Year. Limitations on Contributions Limitations on Employee Salary Deferrals. For the Plan Year beginning January 1, 2002, the amount of a participant's before-tax contributions may not exceed $11,000 per calendar year. The Internal Revenue Service will periodically increase this annual limitation. Contributions in excess of this limit are known as excess deferrals. If a participant defers amounts in excess of this limitation, the participant's gross income for Federal income tax purposes will include the excess in the year of the deferral. In addition, unless the excess deferral is distributed before April 15 of the following year, it will be taxed again in the year distributed. Income on the excess deferral distributed by April 15 of the immediately succeeding year will be treated, for Federal income tax purposes, as earned and received by the participant in the tax year in which the contribution is made. Limitation on Plan Contributions for Highly Compensated Employees. Special provisions of the Internal Revenue Code limit the amount of employee deferrals and employer matching contributions that may be made to the Plan in any year on behalf of highly compensated employees, in relation to the amount of employee deferrals and employer matching contributions made by or on behalf of all other employees eligible to participate in the Plan. A highly compensated employee includes any employee who (1) was a 5% owner of Citizens South Banking Corporation at any time during the current or preceding year, or (2) had compensation for the preceding year of more than $85,000 and, if Citizens South Banking Corporation so elects, was in the top 20% of employees by compensation for the preceding year. The dollar amounts in the foregoing sentence may be adjusted annually to reflect increases in the cost of living. If these limitations are exceeded, the level of deferrals by highly compensated employees may have to be adjusted. 5 Benefits Under the Plan Vesting. A participant, at all times, has a fully vested, nonforfeitable interest in his or her salary deferral contribution and the earnings thereon under the Plan. A participant is vested in any employer contributions in accordance with the following schedule:
Year if Service Vesting Percentage --------------- ------------------ 0 - 2 0% 3 or more 100%
A participant will also be 100% vested in employer contributions regardless of his or her years of vesting service, upon attainment of normal retirement age under the Plan, death or disability. Any non-vested contributions which are forfeited shall be used at the option of Citizens South Bank to (i) reduce administrative expenses or (ii) offset any contribution to be made for the Plan Year. Withdrawals and Distributions From the Plan APPLICABLE FEDERAL LAW REQUIRES THE PLAN TO IMPOSE SUBSTANTIAL RESTRICTIONS ON THE RIGHT OF A PLAN PARTICIPANT TO WITHDRAW AMOUNTS HELD FOR HIS OR HER BENEFIT UNDER THE PLAN PRIOR TO THE PARTICIPANT'S TERMINATION OF EMPLOYMENT WITH CITIZENS SOUTH BANK. A SUBSTANTIAL FEDERAL TAX PENALTY MAY ALSO BE IMPOSED ON WITHDRAWALS MADE PRIOR TO THE PARTICIPANT'S ATTAINMENT OF AGE 59-1/2, REGARDLESS OF WHETHER SUCH A WITHDRAWAL OCCURS DURING HIS OR HER EMPLOYMENT WITH CITIZENS SOUTH BANK OR AFTER TERMINATION OF EMPLOYMENT. Withdrawals Prior to Termination of Employment. A participant may make a withdrawal from his or her elective deferral contributions (and earnings thereon) prior to termination of employment only in the event of financial hardship, subject to the hardship distribution rules under the Plan. These requirements insure that participants have a true financial need before a withdrawal may be made. A participant may make a withdrawal of employer contributions credited to his Regular Account if the participant has completed 60 months of participation in the Plan, the employer contributions have been invested in the Plan for at least 24 months, or the participant has attained age 59 2. Distribution Upon Termination of Employment or Disability. Payment of benefits to a participant who retires, incurs a disability, or otherwise terminates employment shall be made in a lump sum payment or in installments, over a period of up to 20 years. Such period must not extend beyond the life expectancy of the participant. Benefit payments generally may be deferred until retirement, or with respect to a participant owning 5% or more of the Company's stock, April 1 following the calendar year in which the participant attains age 70-1/2. Distribution Upon Death. A participant who dies prior to the benefit commencement date for retirement, disability or termination of employment shall have his or her benefits paid to 6 the surviving spouse or beneficiary in a lump sum, unless the payment would exceed $500, and the participant elected prior to death that the payment be made in annual installments over a period not to exceed 5 years (10 years if the spouse is the beneficiary). If no election is in effect at the time of the participant's death, the beneficiary may elect to receive the benefit in the form of annual installments over a period not to exceed 5 years (10 years if the spouse is the beneficiary). Nonalienation of Benefits. Except with respect to federal income tax withholding and as provided with respect to a qualified domestic relations order (as defined in the Code), benefits payable under the Plan shall not be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, charge, garnishment, execution, or levy of any kind, either voluntary or involuntary, and any attempt to anticipate, alienate, sell, transfer, assign, pledge, encumber, charge or otherwise dispose of any rights to benefits payable under the Plan shall be void. Investment of Contributions and Account Balances All amounts credited to Participants' accounts under the Plan are held in the Plan Trust (the "Trust") which is administered by the Trustee appointed by Citizens South Bank's Board of Directors. As a participant in the Plan, you are provided the opportunity to direct the investment of your account into one of the following funds: 1. Money Market Fund 2. Stable Value Fund 3. Government Bond Fund 4. S& Stock Fund 5. S&P 500/Value Stock Fund 6. S&P 500/Growth Stock Fund 7. S&P MidCap Stock Fund 8. Russell 2000 Stock Fund 9. Nasdaq 100 Stock Fund 10. International Stock Fund 11. Income Plus Asset Allocation Fund 12. Growth & Income Asset Allocation Fund 13. Growth Asset Allocation Fund 14. Employer Stock Fund You may elect to have both past contributions and earnings, as well as future contributions to your account invested among the funds listed above. Transfers of past contributions and the earnings thereon do not affect the investment mix of future contributions. Generally, if you make an election to direct investment of assets into the Employer Stock Fund, you may change your investment on a daily basis. The proceeds of the sale, net of expenses, will be allocated to your account and reinvested in accordance with your election. If you make a special election to invest all or a portion of your account (other than amounts presently invested 7 in the Employer Stock Fund) towards the purchase of Citizens South Banking Corporation common stock in the conversion and common stock offering, you will not be able to change this investment election until the conversion and common stock offering is concluded. Therefore you should carefully consider whether to allocate any portion of your account to the purchase of stock in the offering. Performance History The following provides performance data with respect to the investment funds available under the Plan: Net Investment Performance - Fund Returns -----------------------------------------
YTD Annualized (through 12/31/01) (6/30/02) 1 Yr. 3 Yr. 5 Yr. 1. Money Market Fund % % % % 2. Stable Value Fund % % % % 3. Government Bond Fund % % % % 4. S&P Stock Fund % % % % 5. S&P 500/Value Stock Fund % % % % 6. S&P 500/Growth Stock Fund % % % % 7. S&P MidCap Stock Fund % % % % 8. Russell 2000 Stock Fund % % % % 9. Nasdaq 100 Stock Fund % % % % 10. International Stock Fund % % % % 11. Income Plus Asset Allocation Fund % % % % 12. Growth & Income Asset Allocation Fund % % % % 13. Growth Asset Allocation Fund % % % % 14. Employer Stock Fund % % % %
8 The following is a description of each of the Plan's investment funds: Money Market Fund. The Pentegra Money Market Fund is intended for investors seeking current income while preserving the value of their investment principal. The fund invests in a broad range of high-quality, short-term securities with high credit rating known as money market instruments. These securities are issued by U.S. and foreign corporations, governments, banks and U.S. agencies and have a maturity of one year or less. These investments are considered low risk due to the financial strength of the issuers and the short-term maturity of the securities. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. Stable Value Fund. The Pentegra Stable Value Fund is intended for short-term investors who are seeking to preserve the value of their investments and achieve a stable return. The fund invests primarily in guaranteed investment contracts (GICs), which are individually negotiated investments offered by insurance companies. The fund also invests in synthetic guaranteed investment contracts (SGICs). These contracts are individually negotiated agreements between the fund manager and the insurance company or bank that issues them. Most of these contracts pay a constant rate of interest over a specified period of time. However, the rate of interest for this fund can fluctuate, because individual contracts will mature and be replaced. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. Government Bond Fund. The Pentegra Government Bond Fund is intended for long-term investors seeking a high level of income along with the potential for capital appreciation. The fund tracks its benchmark, the Lehman Brothers 20+ Year Treasury Index. The fund invests in a portfolio of U.S. Treasury bonds with 20 years or more to maturity. Because the fund invests only in bonds backed by the full faith and credit of the U.S. Government, it is not exposed to credit risk. However, due to the long maturity of the bonds, the fund is exposed to interest rate risk and the effects that changes in long-term interest rates may have on the value of bonds which can be substantial. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. S&P 500 Stock Fund. The Pentegra S&P 500 Stock Fund is intended for long-term investors seeking to capture the earnings and growth potential of large U.S. companies. The fund tracks its benchmark, the Standard & Poor's 500 Index. The fund invests in most or all of the same stocks held in the S&P 500 Index. These stocks represent 500 of the largest and most established public companies in the U.S. (based on the market value of their shares), and account for more than 70% of the market capitalization of all publicly traded stocks in the U.S. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. S&P 500/Value Stock Fund. The Pentegra S&P 500/Value Stock Fund is intended for long-term investors seeking a diversified portfolio or large-capitalization value stocks. The fund's goal is to match its benchmark, the S&P/BARRA Value Index. The fund invests in most, or all of the stocks held in the S&P/BARRA Value Index. The S&P/BARRA Value and Growth 9 indexes are constructed by ranking the stocks in the S&P 500 by a single attribute: market price to book value ratio. The S&P/BARRA Value Index includes companies with lower market price to book ratios. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. S&P 500/Growth Stock Fund. The Pentegra S&P/Growth Stock Fund is intended for long-term investors seeking a diversified portfolio of large-capitalization growth stocks. The fund's goal is to match its benchmark, the S&P/BARRA Growth Index. The fund invests in most, or all of the stock held in the S&P/BARRA Growth Index. This index represents approximately 50% of the market capitalization of the S&P 500 Stock Index. The S&P/BARRA Growth and Value indexes are constructed by dividing the stocks in the S&P 500 by a single attribute: market price to book value ratio. The S&P/BARRA Growth Index includes companies with higher price to book ratios. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. S&P MidCap Stock Fund. The Pentegra S&P MidCap Stock Fund is intended for long-term investors seeking high returns that reflect the growth potential of mid-sized U.S. companies. The fund tracks its benchmark, the Standard & Poor's MidCap 400 Index. The fund invests in most or all of the same stocks held in the S&P MidCap 400 Index. These stocks represent the middle tier of the U.S. stock market, while the S&P 500 Index represents the largest tier of the U.S. stock market. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. Russell 2000 Stock Fund. The Pentegra Russell 2000 Stock Fund is intended for long-term investors seeking the potential high returns from investing in smaller U.S. companies. The fund's goal is to match its benchmark, the Russell 2000 Index, which represents 2000 of the smallest companies included in the Russell 3000 Index. The Russell 3000 Index is based on ranking of all U.S. publicly traded companies by market capitalization size. The Russell 2000 represents those 2000 companies ranked by size below the top 1000 companies and it has become one of the better known indexes used to measure the performance of U.S. small company stocks. It is broadly diversified in terms of industries and economic sectors. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. Nasdaq 100 Stock Fund. This fund is intended for long-term investors seeking to capture the growth potential of the 100 largest and most actively traded non-financial companies on the Nasdaq Stock Market. The fund's benchmark is the Nasdaq 100 Index. The fund invests in the same stocks held in the Nasdaq 100 Index. The Nasdaq 100 Index reflects Nasdaq's largest non-financial companies across major industry groups, including computer hardware and software, telecommunications, retail/wholesale trade and biotechnology. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. International Stock Fund. The Pentegra International Stock Fund is intended for long-term investors seeking to capture high returns and diversification by investing in a broad range of foreign stocks. The fund's goal is to match the returns of its benchmark, the Morgan Stanley 10 Capital International EAFE (Europe Australia Far East) Index. The fund invests in a diversified portfolio of approximately 1,000 foreign stocks representing established companies in approximately 20 countries located in Western Europe and the Pacific Rim. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. Income Plus Asset Allocation Fund. This fund is intended for short-to-medium-term investors seeking a lower-risk portfolio of diversified investments. The fund's investments include stable value investments, U.S. stock and bonds, and international stocks. An asset allocation fund provides investors a diversified investment portfolio within a single fund. The fund invests in a diversified portfolio of approximately 70% U.S. bonds, money market instruments and stable value investments such as guaranteed investment contracts (GICs). The other 30% is invested in U.S. and international stocks selected from major indexes, including the S&P 500 Index and the MSCI Europe, Australia and Far East (EAFE) Index. As market conditions change, the fund manager may adjust the portfolio's investments, seeking to maintain the fund's targeted level of risk. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. Growth & Income Asset Allocation Fund. This fund is intended for long-term investors seeking a total portfolio solution for diversified investing. The fund's investments include U.S. stock, international stocks, bonds, and stable value investments. The fund invests in a diversified portfolio of approximately 60% U.S. and international stocks. The remaining 40% of the fund will be held in U.S. fixed income and stable value investments such as guaranteed investment contracts (GICs). Approximately 15% of the fund is invested in a tactical component that includes U.S. stocks, bonds and money market instruments. Most of the time this will be invested 60% in stocks and 40% in bonds. As market conditions change, the fund manager may adjust the portfolio's investments in order to maintain the fund's targeted level of risk. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. Growth Asset Allocation Fund. This fund is intended for long-term investors seeking a total portfolio solution for diversified investments in U.S. and international stock. The fund portfolio is divided among U.S. (80%) and international stocks (20%). Approximately 25% of the fund is invested in a tactical component that includes U.S. stocks, bonds and money market instruments. Most of the time this allocation will be largely invested in U.S. stocks. The fund manager may periodically adjust these investments in response to changing market conditions in order to maintain the fund's targeted level of risk. An investment in the fund is not insured or guaranteed by the FDIC or any other Government agency. It is possible to lose money by investing in the fund. Employer Stock Fund. The Employer Stock Fund consists primarily of investments in common stock of Citizens South Banking Corporation. The trustee will use all amounts reallocated to the Employer Stock Fund in the special election to acquire shares in the conversion and common stock offering. Shares of Citizens South Banking Corporation which were held in the Employer Stock Fund prior to the conversion and common stock offering will be converted into shares of common stock of Citizens South Banking Corporation, in accordance with the exchange ratio. 11 After the offering, the trustee will, to the extent practicable, use all amounts held by it in the Employer Stock Fund, including cash dividends paid on common stock held in the Employer Stock Fund, to purchase shares of common stock of Citizens South Banking Corporation. It is expected that all purchases will be made at prevailing market prices. Under certain circumstances, the trustee may be required to limit the daily volume of shares purchased. Pending investment in common stock, amounts allocated towards the purchase of shares in the offering will be held in the Employer Stock Fund in an interest-bearing account. In the event of an oversubscription, any earnings that result therefrom will be reinvested among the other funds of the Plan in accordance with your then existing investment election (in proportion to your investment direction allocation percentages). Following the offering, Citizens South Banking Corporation, a Delaware corporation, will be 100% owned by its public shareholders, including Citizens South Bank's tax-qualified plans. Currently, Citizens South Banking Corporation is a majority owned subsidiary of Citizens South Holdings, MHC, a mutual holding company. The historical performance of the Employer Stock Fund is set forth on page 8. Performance of the Employer Stock Fund will be dependent upon a number of factors, including the financial condition and profitability of Citizens South Banking Corporation and Citizens South Bank and market conditions for the common stock generally. An investment in the fund is not insured or guaranteed by the FDIC or any other government agency. It is possible to lose money by investing in the fund. Administration of the Plan The Trustee. The trustee of the Plan is The Bank of New York. The trustee receives, holds and invests the contributions to the Plan in trust and distributes them to you and your beneficiaries in accordance with the terms of the Plan and the directions of the Plan Administrator. The trustee is responsible for investment of the assets of the trust. Plan Administrator. Pursuant to the terms of the Plan, the Plan is administered by the plan administrator (the "Plan Administrator"). Citizens South Bank is the Plan Administrator and has designated a committee consisting of Kim S. Price, Paul L. Teem, Jr. and Betty B. Gaddis, to supervise its responsibilities as such. The address of the Plan Administrator is Citizens South Bank, Attention: Kim S. Price, President and Chief Executive Officer, 245 West Main Avenue, P. O. Box 2249, Gastonia, North Carolina 28053-2249, Telephone number (704) 868-5200. The Plan Administrator is responsible for the administration of the Plan, interpretation of the provisions of the Plan, prescribing procedures for filing applications for benefits, preparation and distribution of information explaining the Plan, maintenance of plan records, books of account and all other data necessary for the proper administration of the Plan, and preparation and filing of all returns and reports relating to the Plan which are required to be filed with the U.S. Department of Labor and the IRS, and for all disclosures required to be made to participants, beneficiaries, and others under Sections 104 and 105 of ERISA. Reports to Plan Participants. The Plan Administrator will furnish you a statement at least quarterly showing the balance in your account as of the end of that period, the amount 12 of contributions allocated to your account for that period, and adjustments to your account to reflect earnings or losses (if any). Amendment and Termination It is the intention of Citizens South Bank to continue the Plan indefinitely. Nevertheless, Citizens South Bank may terminate the Plan at any time. If the Plan is terminated in whole or in part, then regardless of other provisions in the Plan, each employee affected by such termination will have a fully vested interest in his or her accounts. Citizens South Bank reserves the right to make any amendment or amendments to the Plan which do not cause any part of the trust to be used for, or diverted to, any purpose other than the exclusive benefit of participants or their beneficiaries; provided, however, that Citizens South Bank may make any amendment it determines necessary or desirable, with or without retroactive effect, to comply with the Employee Retirement Income Security Act. Merger, Consolidation or Transfer In the event of the merger or consolidation of the Plan with another Plan, or the transfer of the trust assets to another plan, the Plan requires that each participant would, if either the Plan or the other plan terminates, receive a benefit immediately after the merger, consolidation or transfer which is equal to or greater than the benefit he or she would have been entitled to receive immediately before the merger, consolidation or transfer, if the Plan had then terminated. Federal Income Tax Consequences The following is a brief summary of the material federal income tax aspects of the Plan. You should not rely on this summary as a complete or definitive description of the material federal income tax consequences relating to the Plan. Statutory provisions change, as do 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. You are advised to consult your tax advisor with respect to any distribution from the Plan and transactions involving the Plan. As a "tax-qualified retirement plan," the Internal Revenue Code affords the Plan special tax treatment, including: (1) the sponsoring employer is allowed an immediate tax deduction for the amount contributed to the Plan each year; (2) Participants pay no current income tax on amounts contributed by the employer on their behalf; and (3) earnings of the Plan are tax-deferred, thereby permitting the tax-free accumulation of income and gains on investments. 13 Lump-Sum Distribution. A distribution from the Plan to a participant or the beneficiary of a participant will qualify as a lump-sum distribution if it is made within one taxable year, on account of the participant's death, disability or separation from service, or after the participant attains age 59 1/2; and consists of the balance credited to participants under the Plan and all other profit sharing plans, if any, maintained by Citizens South Bank. The portion of any lump-sum distribution required to be included in the participant's or beneficiary's taxable income for federal income tax purposes consists of the entire amount of the lump-sum distribution, less the amount of after-tax contributions, if any, made by the participant to the Plan and any other profit sharing plans maintained by Citizens South Bank, which is included in the distribution. Citizens South Banking Corporation Common Stock Included in Lump-Sum Distribution. If a lump-sum distribution includes Citizens South Banking Corporation common stock, the distribution generally will be taxed in the manner described above, except that the total taxable amount may be reduced by the amount of any net unrealized appreciation with respect to Citizens South Banking Corporation common stock; that is, the excess of the value of Citizens South Banking Corporation common stock at the time of the distribution over its cost or other basis of the securities to the trust. The tax basis of Citizens South Banking Corporation common stock to the participant or beneficiary, for purposes of computing gain or loss on its subsequent sale, equals the value of Citizens South Banking Corporation common stock at the time of distribution, less the amount of net unrealized appreciation. Any gain on a subsequent sale or other taxable disposition of Citizens South Banking Corporation common stock, to the extent of the amount of net unrealized appreciation at the time of distribution, will constitute long-term capital gain, regardless of the holding period of Citizens South Banking Corporation common stock. Any gain on a subsequent sale or other taxable disposition of Citizens South Banking Corporation common stock, in excess of the amount of net unrealized appreciation at the time of distribution, will be considered long-term capital gain. The recipient of a distribution may elect to include the amount of any net unrealized appreciation in the total taxable amount of the distribution, to the extent allowed by regulations to be issued by the Internal Revenue Service. Distributions: Rollovers and Direct Transfers to Another Qualified Plan or to an IRA. A participant may roll over virtually all distributions from the Plan to another qualified plan or to an individual retirement account in accordance with the terms of the other plan or account. Additional Employee Retirement Income Security Act ("ERISA") Considerations As noted above, the Plan is subject to certain provisions of ERISA, including special provisions relating to control over the Plan's assets by participants and beneficiaries. The Plan's feature that allows participants to direct the investments of their account balances is intended to satisfy the requirements of section 404(c) of ERISA relating to control over plan assets by a participant or beneficiary. The effect of this is two-fold. First, a participant will not be deemed a "fiduciary" because of his or her exercise of investment discretion. Second, no person who otherwise is a fiduciary, such as the Plan Administrator or the plan's trustee is liable under the fiduciary responsibility provision of ERISA for any loss which results from a participant's exercise of control over the assets in the participant's Plan account. 14 Because a participant will be entitled to invest all or a portion of his or her account balance in the Plan in Citizens South Banking Corporation common stock, the regulations under section 404(c) of the ERISA require that the Plan establish procedures that ensure the confidentiality of the participant's decision to purchase, hold, or sell employer securities, except to the extent that disclosure of such information is necessary to comply with Federal or state laws not preempted by ERISA. These regulations also require that a participant's exercise of voting and similar rights with respect to the common stock be conducted in a way that ensures the confidentiality of the participant's exercise of these rights. Securities and Exchange Commission Reporting and Short-Swing Profit Liability Section 16 of the Securities Exchange Act of 1934 imposes reporting and liability requirements on officers, directors, and persons beneficially owning more than 10% of public companies such as Citizens South Banking Corporation. Section 16(a) of the Securities Exchange Act of 1934 requires the filing of reports of beneficial ownership. Within 10 days of becoming an officer, director or person beneficially owning more than 10% of the shares of Citizens South Banking Corporation, a Form 3 reporting initial beneficial ownership must be filed with the Securities and Exchange Commission. Changes in beneficial ownership, such as purchases, sales and gifts generally must be reported periodically, either on a Form 4 within 10 days after the end of the month in which a change occurs, or annually on a Form 5 within 45 days after the close of Citizens South Banking Corporation's fiscal year. Discretionary transactions in and beneficial ownership of the common stock through the Employer Stock Fund of the Plan by officers, directors and persons beneficially owning more than 10% of the common stock of Citizens South Banking Corporation generally must be reported to the Securities and Exchange Commission by such individuals. In addition to the reporting requirements described above, section 16(b) of the Securities Exchange Act of 1934 provides for the recovery by Citizens South Banking Corporation of profits realized by an officer, director or any person beneficially owning more than 10% of Citizens South Banking Corporation's common stock resulting from non-exempt purchases and sales of Citizens South Banking Corporation common stock within any six-month period. The Securities and Exchange Commission has adopted rules that provide exemptions from the profit recovery provisions of section 16(b) for all transactions in employer securities within an employee benefit plan, provided certain requirements are met. These requirements generally involve restrictions upon the timing of elections to acquire or dispose of employer securities for the accounts of section 16(b) persons. Except for distributions of common stock due to death, disability, retirement, termination of employment or under a qualified domestic relations order, persons affected by section 16(b) are required to hold shares of common stock distributed from the Plan for six months following such distribution and are prohibited from directing additional purchases of units within the Employer Stock Fund for six months after receiving such a distribution. 15 Financial Information Regarding Plan Assets Financial information representing the net assets available for the Plan benefits at ____________ __, 200__, are attached to this prospectus supplement. LEGAL OPINION The validity of the issuance of the common stock will be passed upon by Luse Gorman Pomerenk & Schick, P.C., Washington, D.C., which firm acted as special counsel to Citizens South Bank in connection with Citizens South Banking Corporation's stock offering. 16 CITIZENS SOUTH BANK Employees' Savings & Profit Sharing Plan Statement of Net Assets Available for Benefits ______________ __, 200__ 17 PROSPECTUS CITIZENS SOUTH BANKING CORPORATION (Holding Company for Citizens South Bank) Up to 4,600,000 Shares of Common Stock Citizens South Banking Corporation is offering common stock for sale in connection with the conversion of Citizens South Holdings, MHC from the mutual to the stock form of organization. The shares we are offering represent the ownership interest in Citizens South Banking Corporation now owned by Citizens South Holdings, MHC. The existing publicly held shares of Citizens South Banking Corporation, which represent the remaining interest in Citizens South Banking Corporation, will be exchanged for new shares of common stock of Citizens South Banking Corporation. All shares offered for sale are offered at a price of $10.00 per share. Our common stock will continue to trade on the Nasdaq National Market under the symbol "CSBC." . If you are or were a customer of Citizens South Bank, you may have priority rights to purchase shares. . If you are a stockholder of Citizens South Banking Corporation, your shares will be exchanged for new shares of Citizens South Banking Corporation. You may purchase additional shares in the offering after priority orders are filled. ================================================================================ OFFERING SUMMARY Price: $10.00 per Share Minimum Maximum ------- ------- Number of shares: 3,400,000 4,600,000 Gross offering proceeds: $ 34,000,000 $ 46,000,000 Estimated offering expenses: $ 1,010,250 $ 1,169,010 Estimated net proceeds: $ 32,989,750 $ 44,830,990 Estimated net proceeds per share: $ 9.70 $ 9.75 We may sell up to 5,290,000 shares because of regulatory considerations or changes in market conditions without resoliciting subscribers. ================================================================================ We are offering the common stock for sale on a best efforts basis, subject to certain conditions. Keefe, Bruyette & Woods, Inc. will assist us in our selling efforts, but is not required to purchase any of the common stock that is being offered for sale. Purchasers will not pay a commission to purchase common stock in the offering. We will terminate the offering and the exchange of existing shares if we do not sell the minimum number of shares. The offering is expected to terminate at 12:00 noon, North Carolina Time, on September 18, 2002. We may extend this termination date without notice to you until November 2, 2002, unless the Office of Thrift Supervision approves a later date. The minimum purchase is 25 shares. Once submitted, orders are irrevocable unless the offering is terminated or extended beyond November 2, 2002. If the offering is extended beyond November 2, 2002, subscribers will have the right to modify or rescind their purchase orders. Funds received prior to completion of the offering will be held in an escrow account at Citizens South Bank and will earn interest at our passbook rate. This investment involves a degree of risk, including the possible loss of principal. Please read "Risk Factors" beginning on page __. These securities are not deposits or accounts and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Neither the Securities and Exchange Commission, the Office of Thrift Supervision, nor any state securities regulator has approved or disapproved of these securities or determined if this prospectus is accurate or complete. Any representation to the contrary is a criminal offense. KEEFE, BRUYETTE & WOODS, INC. The date of this prospectus is August __, 2002 [INSERT MAP SHOWING CITIZENS SOUTH MARKET AREA] TABLE OF CONTENTS
Page SUMMARY ................................................................... 1 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA OF CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARY ....................................... 10 RISK FACTORS .............................................................. 12 FORWARD-LOOKING STATEMENTS ................................................ 16 HOW WE INTEND TO USE THE PROCEEDS FROM THE OFFERING ....................... 16 OUR DIVIDEND POLICY ....................................................... 18 MARKET FOR THE COMMON STOCK ............................................... 18 HISTORICAL AND PRO FORMA REGULATORY CAPITAL COMPLIANCE .................... 20 CAPITALIZATION ............................................................ 21 PRO FORMA DATA ............................................................ 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS .................................................... 27 BUSINESS OF CITIZENS SOUTH BANKING CORPORATION AND CITIZENS SOUTH BANK ..................................................................... 39 SUPERVISION AND REGULATION ................................................ 57 TAXATION .................................................................. 63 MANAGEMENT OF CITIZENS SOUTH BANKING CORPORATION .......................... 64 BENEFICIAL OWNERSHIP OF COMMON STOCK ...................................... 72 SUBSCRIPTIONS BY EXECUTIVE OFFICERS AND DIRECTORS ......................... 73 THE CONVERSION ............................................................ 73 COMPARISON OF STOCKHOLDERS' RIGHTS ........................................ 91 RESTRICTIONS ON ACQUISITION OF CITIZENS SOUTH BANKING CORPORATION ......... 96 DESCRIPTION OF CAPITAL STOCK OF CITIZENS SOUTH BANKING CORPORATION FOLLOWING THE CONVERSION ................................................. 98 TRANSFER AGENT ............................................................ 99 EXPERTS ................................................................... 99 LEGAL MATTERS ............................................................. 99 ADDITIONAL INFORMATION .................................................... 99 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS CITIZENS SOUTH BANKING COPORATION AND SUBSIDIAIRIES ...................... F-1 INNES STREET HISTORICAL AND PRO FORMA FINANCIAL DATA ...................... G-1 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS INNES STREET FINANCIAL CORPORATION ....................................... G-5
SUMMARY The following summary explains the significant aspects of the conversion, the offering and the exchange of existing shares of Citizens South Banking Corporation common stock for new shares of Citizens South Banking Corporation common stock. It may not contain all the information that is important to you. For additional information, you should read this entire document carefully, including the consolidated financial statements and the notes to the consolidated financial statements. The Companies Citizens South Holdings, MHC Citizens South Holdings, MHC (which changed its name from Gaston Federal Holdings, MHC in May 2002) is the federally chartered mutual holding company of Citizens South Banking Corporation. Citizens South Holdings, MHC's principal business activity is the ownership of 2,457,007 shares of common stock of Citizens South Banking Corporation. At the conclusion of the mutual-to-stock conversion, Citizens South Holdings, MHC will no longer exist. Citizens South Banking Corporation Citizens South Banking Corporation (which changed its name from Gaston Federal Bancorp, Inc. in May 2002) is a federally chartered stock holding company that owns all of the outstanding common stock of Citizens South Bank. As of June 30, 2002, Citizens South Banking Corporation had __________ issued and outstanding shares of common stock. Citizens South Holdings, MHC owned 2,457,007 shares of Citizens South Banking Corporation's outstanding common stock. The remaining __________ shares are held by the public. At June 30, 2002, Citizens South Banking Corporation had consolidated assets of $______, deposits of $_________ and stockholders' equity of $________. Following the conversion, Citizens South Banking Corporation will cease to exist, but will be succeeded by a new Delaware corporation with the same name. Citizens South Bank Citizens South Bank (which changed its name from Gaston Federal Bank in March 2002) is a federally chartered community bank headquartered in Gastonia, North Carolina. Citizens South Bank was chartered in 1904. Our principal business activity is originating single-family mortgage loans, multi-family and commercial real estate loans, construction loans, commercial business loans and consumer loans. We also offer a range of deposit accounts and other financial services. Our deposits are insured by the Federal Deposit Insurance Corporation up to the maximum amount permitted by law. We operate through our nine full-service banking offices in the North Carolina Counties of Gaston, Rowan and Iredell. On December 31, 2001, Citizens South Banking Corporation completed its acquisition of Innes Street Financial Corporation and its wholly owned subsidiary, Citizens Bank, Inc., in a cash acquisition for approximately $38 million. At the time of the acquisition, Innes Street Financial Corporation had total assets of $221.8 million, net outstanding loans of $170.5 million and total deposits of $175.4 million. Because the acquisition was consummated on December 31, 2001, the assets and liabilities of Innes Street Financial Corporation are included in our consolidated statements of condition at December 31, 2001. However, the results of operations of Innes Street Financial Corporation have not been included in our consolidated financial statements for the period beginning after completion of the acquisition. Beginning at page G-1 of this prospectus, we have included certain historical financial statements of Innes Street Financial Corporation as well as certain pro forma financial statements giving effect to the acquisition. Our Organizational Structure In 1998, Citizens South Bank's mutual predecessor reorganized into the mutual holding company form of organization. As a part of the mutual holding company reorganization, Citizens South Banking Corporation sold a minority of its common stock to our customers in a subscription offering. The majority of our outstanding shares 1 were retained by Citizens South Holdings, MHC. Citizens South Holdings, MHC is a mutual holding company that has no stockholders. Citizens South Banking Corporation owns 100% of the outstanding shares of Citizens South Bank. Pursuant to the terms of our plan of conversion and reorganization, we will convert from the mutual holding company to the fully public form of corporate structure. As part of the conversion, we are offering for sale in a subscription offering and a community offering the majority ownership interest of Citizens South Banking Corporation that is currently held by Citizens South Holdings, MHC. Upon the completion of the conversion and offering, Citizens South Holdings, MHC will cease to exist, and we will complete the transition from partial to full public ownership. At the conclusion of the conversion, existing public stockholders of Citizens South Banking Corporation will receive new shares of common stock in exchange for their existing shares of Citizens South Banking Corporation. Additional shares of common stock will be issued to purchasers in the offering. The following chart shows our ownership structure, which is commonly referred to as the "two-tier" mutual holding company structure: Citizens South Holdings, MHC Public Stockholders 58.4% of | | 41.6% of Citizens South | | Citizens South Banking | | Banking Corporation | | Corporation common stock | | common stock Citizens South Banking Corporation | | 100% of common stock Citizens South Bank After the conversion and offering are completed, our ownership structure will be as follows: Public Stockholders | | 100% of common stock Citizens South Banking Corporation | | 100% of common stock Citizens South Bank 2 Business Strategy Our business strategy is to grow and enhance our profitability by: . acquiring other financial institutions or branches or financial services companies, as opportunities arise; . reducing reliance on net interest income by increasing fee income from our products and services; . improving net interest margin through a combination of reduced funding costs and improved loan pricing; . maintaining high asset quality; and . continuing to emphasize operating efficiencies and cost control. Reasons for the Conversion The primary reasons for the conversion are to facilitate acquisitions of other financial institutions as opportunities arise, to support internal growth through lending in communities we serve, to improve our overall competitive position and to enhance shareholder returns through higher earnings and capital management strategies. As a fully converted stock holding company, we will have greater flexibility in structuring mergers and acquisitions, including the form of consideration paid in a transaction. Our current mutual holding company structure, by its nature, limits our ability to offer our common stock as consideration in a merger or acquisition. Potential sellers often want stock for at least part of the purchase price. Our new stock holding company structure will enhance our ability to compete with other bidders when acquisition opportunities arise by enabling us to offer stock or cash consideration, or a combination thereof. We do not now have any specific acquisition or expansion plans. Terms of the Conversion and Offering Pursuant to our plan of conversion, our organization will convert from a partially public to a fully public form of holding company structure. In connection with the conversion, we are selling in the offering common stock representing the ownership interest in Citizens South Banking Corporation now owned by Citizens South Holdings, MHC. We are selling between 3,400,000 and 4,600,000 shares of common stock to qualifying depositors and to the public, to the extent shares remain available. The number of shares to be sold may be increased up to 5,290,000 as a result of strong demand for the shares in the offering or positive changes in the market for financial institution stocks. Unless the number of shares to be sold is increased to more than 5,290,000 or decreased to less than 3,400,000, you will not have the opportunity to change or cancel your stock order. The offering price is $10.00 per share. Keefe, Bruyette & Woods, Inc., our marketing advisor in the offering, will use its best efforts to assist us in selling our stock. Keefe, Bruyette & Woods, Inc. is not obligated to purchase any shares in the offering. Persons Who May Order Stock in the Offering Under the plan of conversion, we are offering the shares of common stock of Citizens South Banking Corporation in a "subscription offering" in the following descending order of priority: (1) First, depositors with accounts at Citizens South Bank with aggregate balances of at least $50 on March 31, 2001. (2) Second, Citizens South Banking Corporation's employee stock ownership plan. (3) Third, depositors with accounts at Citizens South Bank with aggregate balances of at least $50 on June 30, 2002. 3 (4) Fourth, depositors of Citizens South Bank as of July 31, 2002. The shares of common stock not purchased in the subscription offering will be offered in a "direct community offering," with a preference given first to public stockholders of Citizens South Banking Corporation as of July 31, 2002, and then to natural persons residing in the North Carolina Counties of Gaston, Rowan, Iredell, Mecklenburg, Cabarrus, Lincoln and Cleveland, and the South Carolina County of York. The direct community offering, if it occurs at all, may begin concurrently with, during or promptly after the subscription offering. We also may offer shares of common stock not purchased in the subscription offering or community offering through a "syndicated community offering" managed by Keefe, Bruyette & Woods, Inc. We have the right to accept or reject, in our sole discretion, orders received in the direct community offering or syndicated community offering. How We Determined the Offering Range and the $10.00 Per Share Stock Price The amount of common stock we are offering is based on an independent appraisal of the estimated market value of Citizens South Banking Corporation, assuming the conversion and offering are completed. RP Financial, LC., the independent appraiser, has estimated that, as of June 14, 2002, this market value ranged from $58.3 million to $78.8 million, with a midpoint of $68.5 million. Based on this valuation, the ownership interest of Citizens South Holdings, MHC being sold in the offering and the $10.00 per share price, the number of shares of common stock being offered for sale by Citizens South Banking Corporation will range from 3,400,000 shares to 4,600,000 shares. The $10.00 per share price was selected primarily because it is the price most commonly used in mutual-to-stock conversions of financial institutions. The appraisal was based in part on Citizens South Banking Corporation's financial condition and results of operations, the effect of the additional capital raised by the sale of common stock in the offering, and an analysis of a peer group of publicly-traded savings bank and thrift holding companies that RP Financial, LC. considered comparable to Citizens South Banking Corporation. The independent appraisal will be updated prior to the completion of the conversion. If the market value changes to either below $58.3 million or above $90.6 million, subscribers will be notified and provided with the opportunity to modify or cancel their orders. The Exchange of Existing Shares of Citizens South Banking Corporation Common Stock If you are now a stockholder of Citizens South Banking Corporation, your existing shares will be cancelled and exchanged for new shares of Citizens South Banking Corporation. The number of shares you receive will be based on an exchange ratio determined as of the closing of the conversion, which will depend upon the final appraised value of Citizens South Banking Corporation. The following table shows how the exchange ratio will adjust, based on the number of shares sold in our offering. The table also shows how many shares a hypothetical owner of Citizens South Banking Corporation common stock would receive in the exchange, based on the number of shares sold in the offering.
New Shares to be Exchanged New Shares to New Shares to be Sold in for Existing Shares of Citizens Total Shares of be Received for This Offering South Banking Corporation Common Stock to Exchange 100 Existing ----------------------- -------------------------- Amount Percent Amount Percent be Outstanding Ratio Shares --------- ----------- --------- ----------- --------------- ------- ------ Minimum 3,400,000 58.4% 2,425,004 41.6% 5,825,004 1.3838 138.38 Midpoint 4,000,000 58.4% 2,852,946 41.6% 6,852,946 1.6280 162.80 Maximum 4,600,000 58.4% 3,280,888 41.6% 7,880,888 1.8722 187.22 15% above Maximum 5,290,000 58.4% 3,773,021 41.6% 9,063,021 2.1530 215.30
If you hold shares of Citizens South Banking Corporation in "street name," you do not need to take any action to exchange the shares. If you hold Citizens South Banking Corporation stock certificates after the conversion and offering are completed, you will receive a transmittal form with instructions to surrender stock certificates. New certificates of Citizens South Banking Corporation common stock will be mailed within five business days after the exchange agent receives properly executed transmittal forms and certificates. 4 New shares of Citizens South Banking Corporation issued in exchange for existing shares are considered acquired in an initial public offering. Accordingly, such new shares cannot be owned on margin for 30 days after the offering. If a shareholder owns our stock on margin, the shares would have to be moved to a cash account prior to exchanging the old stock certificates for new stock certificates. No fractional shares of Citizens South Banking Corporation common stock will be issued to any public stockholder of Citizens South Banking Corporation upon consummation of the conversion. For each fractional share that would otherwise be issued, Citizens South Banking Corporation will pay in cash an amount equal to the product obtained by multiplying the fractional share interest to which the holder would otherwise be entitled by the $10.00 per share subscription price. Under federal regulations, current stockholders of Citizens South Banking Corporation do not have dissenters' rights or appraisal rights in connection with the conversion. Limits on How Much Common Stock You May Purchase The minimum number of shares that may be purchased is 25. If you are not now a Citizens South Banking Corporation stockholder - No individual may purchase more than 50,000 shares. If any of the following persons purchase stock, their purchases when combined with your purchases cannot exceed 50,000 shares: . your spouse or relatives of you or your spouse living in your house; . companies, trusts or other entities in which you have an interest or hold a position; or . other persons who may be acting in concert with you. If you are now a Citizens South Banking Corporation stockholder - In addition to the above purchase limitations, there is an ownership limitation. Shares that you purchase in the offering individually and together with persons acting in concert with you as described above, plus new shares you and they receive in the exchange for existing Citizens South Banking Corporation common stock, may not exceed 175,000. Subject to Office of Thrift Supervision approval, we may increase or decrease the purchase and ownership limitations at any time. How You May Purchase Common Stock In the subscription offering and direct community offering, you may pay for your shares only by: (1) personal check, bank check or money order; or (2) authorizing us to withdraw funds from Citizens South Bank deposit accounts designated on the stock order form. Citizens South Bank is not permitted to lend funds to anyone for the purpose of purchasing our common stock in the offering. Additionally, you may not use a Citizens South Bank line of credit to pay for common stock. You can subscribe for shares of common stock in the offering by delivering a signed and completed original stock order form, together with full payment, provided that we receive the stock order form before the end of the offering. We will pay interest at Citizens South Bank's passbook savings rate, from the date funds are received until completion or termination of the conversion. Withdrawals from certificates of deposit may be made without incurring an early withdrawal penalty. All funds authorized for withdrawal from deposit accounts with Citizens South Bank must be in the accounts at the time the stock order is received. However, funds will not be withdrawn from the accounts until the completion of the offering and will earn interest at the applicable deposit account rate until the completion of the offering. A hold will be placed on those funds when your stock order is 5 received, making the designated funds unavailable to you. After we receive an order, the order cannot be withdrawn or changed, except with our consent. You may subscribe for shares using funds in your Individual Retirement Account at Citizens South Bank or elsewhere. However, common stock must be held in a self-directed retirement account. By regulation, Citizens South Bank's IRAs are not self-directed, so they cannot be invested in stock. If you wish to use some or all of the funds in your Citizens South Bank IRA, the applicable funds must be transferred to a self-directed account maintained by an independent trustee, such as a brokerage firm. If you do not have such an account, you will need to establish one before placing your stock order. An annual administrative fee may be payable to the independent trustee. Because individual circumstances differ and processing of retirement fund orders takes additional time, we recommend that you contact the stock information center promptly, preferably at least two weeks before the end of the offering period, for assistance with purchases using your IRA or other retirement account that you may have. Whether you may use such funds for the purchase of shares in the stock offering may depend on timing constraints and, possibly, limitations imposed by the institution where the funds are held. How We Intend to Use the Proceeds From the Offering We estimate net proceeds will be between $33.0 million and $44.8 million, or $51.6 million if the offering range is increased by 15%. Citizens South Banking Corporation intends to retain approximately 50% of the net proceeds (between $16.5 million and $22.4 million, or $25.8 million if the offering range is increased by 15%). Approximately $16.5 million to $22.4 million of the net proceeds (or $25.8 million if the offering range is increased by 15%) will be invested in Citizens South Bank. The net proceeds will be used for general corporate purposes. Citizens South Banking Corporation may use the funds to pay cash dividends and repurchase shares of common stock. Funds invested in Citizens South Bank will be used to support increased lending and to offer new products and banking services. The net proceeds also may be used for future business expansion through acquisitions or establishing new branches. We do not now have any specific acquisition or expansion plans. Initially, the net proceeds will be invested in short-term investments and investment-grade debt obligations, and mortgage-backed securities. A portion of the net proceeds also may be used to provide a loan to the employee stock ownership plan to fund the purchase of common stock in the offering. You May Not Sell or Transfer Your Subscription Rights If you order stock in the subscription offering, you will be required to state that you are purchasing the stock for yourself and that you have no agreement or understanding to sell or transfer your subscription rights. We intend to take legal action, including reporting persons to federal or state regulatory agencies, against anyone who we believe sells or gives away their subscription rights. We will not accept your order if we have reason to believe that you sold or transferred your subscription rights. In addition, you may not add the names of others for joint stock registration unless they were eligible to purchase common stock in the subscription offering on the applicable date of eligibility. Deadlines for Orders of Common Stock If you wish to purchase shares, a properly completed stock order form, together with payment for the shares, must be received by Citizens South Banking Corporation no later than 12:00 noon, North Carolina Time, on September 18, 2002, unless we extend this deadline. You may submit your order form by mail using the return envelope provided, by overnight courier to the indicated address on the order form, or by delivery to the stock information center. Stock order forms may be delivered in person to our branch offices. Once submitted, your order is irrevocable unless the offering is terminated or extended beyond November 2, 2002. 6 Termination of the Offering The subscription offering will terminate at 12:00 noon, North Carolina Time, on September 18, 2002. We expect that the community offering will terminate at the same time. We may extend this expiration date without notice to you, until November 2, 2002, unless regulators approve a later date. If the subscription offering and/or community offering extend beyond November 2, 2002, we will be required to resolicit subscriptions before proceeding with the offering. Steps We May Take if We do Not Receive Orders for the Minimum Number of Shares If we do not receive orders for at least 3,400,000 shares of common stock, we may take several steps in order to sell the minimum number of shares in the offering range. Specifically, we may increase the purchase limitations and we may seek regulatory approval to extend the offering beyond the September 18, 2002 expiration date, provided that any such extension will require us to resolicit subscriptions received in the offering. Purchases by Officers and Directors We expect our directors and executive officers, together with their families, to subscribe for _______ shares, which equals approximately ___% of the shares sold at the midpoint of the offering range. The purchase price paid by them will be the same $10.00 per share price paid by all other persons who purchase shares in the offering. Following the conversion, our directors and executive officers, together with their associates, are expected to own _________ shares of common stock, or ___% of our outstanding common stock if shares are sold at the midpoint of the offering range. Benefits to Management and Potential Dilution to Stockholders Resulting from the Conversion Our employee stock ownership plan expects to purchase up to 2% of the shares we sell in the offering, or 92,000 shares, assuming we sell the maximum of the shares proposed to be sold. If we sell more shares than the maximum of the offering range, this plan will have first priority to purchase shares over this maximum, up to the total of 2%. We reserve the right to purchase common stock in the open market following the offering in order to fund the employee stock ownership plan. This plan is a tax-qualified retirement plan for all eligible employees. Assuming the plan purchases 92,000 shares in the offering, we will recognize additional compensation expense of $920,000 over a period of 15 years, or approximately $61,000 per year, from the consummation of the conversion, assuming the shares have a fair market value of $10.00 per share for the full 15-year period. If, in the future, the shares have a fair market value greater or less than $10.00, the compensation expense will increase or decrease accordingly. We also intend to implement two stock-based incentive plans no earlier than six months after the conversion, and stockholder approval of such plans would be required. The stock recognition and retention plan is a restricted stock plan that would reserve an amount equal to 4% of the shares sold in the offering, or 184,000 shares at the maximum of the offering range, for awards to key employees and directors, at no cost to the recipients. If the shares awarded under the stock recognition and retention plan come from authorized but unissued shares, stockholders would experience dilution of approximately 2.3% in their ownership interest in Citizens South Banking Corporation The second plan would be a stock option plan, and would reserve an amount equal to 10% of the shares sold in the offering, or up to 460,000 shares at the maximum of the offering range, for key employees and directors upon their exercise. If the shares issued upon the exercise of options come from authorized but unissued shares, stockholders would experience dilution of approximately 5.5% in their ownership interest in Citizens South Banking Corporation. Awards made under these plans would be subject to vesting over a period of years. We also will convert options previously awarded under our current stock option plan into options to purchase Citizens South Banking Corporation common stock, with the number and exercise price to be adjusted, based on the exchange ratio. The term and vesting period of the previously awarded options will remain unchanged. 7 The following table summarizes the number of shares and aggregate dollar value of grants that are expected under the new stock recognition and retention plan and the new stock option plan as a result of the conversion. A portion of the stock grants shown in the table below may be made to non-management employees.
Number of Shares to be Granted or Purchased ------------------------------------------- Dilution As a Resulting Value of Grants (1) Percentage From --------------------------- At At of Common Issuance of At At Minimum Maximum Stock to be Shares for Minimum Maximum of Offering of Offering Sold in the Stock Benefit of Offering of Offering Range Range Offering Plans Range Range ----- ----- -------- ----- ----- ----- Employee stock ownership plan .... 68,000 92,000 2% N/A $ 680,000 $ 920,000 Recognition and retention plan ... 136,000 184,000 4% 2.3% 1,360,000 1,840,000 Stock option plan ................ 340,000 460,000 10% 5.5% -- -- ------- ------- --- ------------ ------------ Total ......................... 544,000 736,000 16% 7.6% $ 2,040,000 $ 2,760,000 ======= ======= === ============ ============
____________ (1) The actual value of restricted stock grants will be determined based on their fair value as of the date grants are made. For purposes of this table, fair value is assumed to be the same as the offering price of $10.00 per share. No value is given for options because their exercise price will be equal to the fair market value of the common stock on the day the options are granted. As a result, value can be realized under an option only if the market price of the common stock increases after the option grant. Market for Common Stock Existing publicly held shares of our common stock trade on the Nasdaq National Market under the symbol "CSBC." Upon completion of the conversion, the new shares of common stock of Citizens South Banking Corporation will replace existing shares and will be traded on the Nasdaq National Market. For a period of 20 trading days following completion of our offering, our symbol will be "CSBCD." Thereafter it will be "CSBC." Keefe, Bruyette & Woods, Inc. currently intends to remain a market maker in the common stock and will assist us in obtaining additional market makers. Our Dividend Policy Citizens South Banking Corporation currently pays a cash dividend of $0.08 per share per quarter, or $0.32 per share per year. After the conversion, we intend to continue to pay cash dividends on a quarterly basis. We expect such dividends to equal $0.23, $0.20, $0.17 and $0.15 per share per year at the minimum, midpoint, maximum and adjusted maximum of the offering range, respectively, which represents an annual dividend yield of 2.3%, 2.0%, 1.7% and 1.5%, at the minimum, midpoint, maximum and adjusted maximum of the offering range, respectively, based upon a price of $10.00 per share. The amount of dividends that we intend to pay after the conversion will preserve or increase the per share dividend amount, adjusted to reflect the exchange ratio, that Citizens South Banking Corporation stockholders currently receive. The dividend rate and the continued payment of dividends will depend on a number of factors, including our capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic conditions. No assurance can be given that we will continue to pay dividends or that they will not be reduced in the future. Tax Consequences The conversion will not be a taxable transaction to Citizens South Holdings, MHC, Citizens South Banking Corporation, Citizens South Bank, existing stockholders of Citizens South Banking Corporation, or persons eligible to subscribe in the offering, with respect to federal or state income tax. Conditions to Completion of the Conversion We cannot complete our conversion and related offering unless: . The plan of conversion is approved by at least a majority of votes eligible to be cast by members of Citizens South Holdings, MHC (depositors of Citizens South Bank); 8 . The plan of conversion is approved by the holders of at least two-thirds of the outstanding shares of Citizens South Banking Corporation common stock; . The plan of conversion is approved by at least a majority of the votes cast by stockholders of Citizens South Banking Corporation common stock, not including those shares held by Citizens South Holdings, MHC; . We sell at least the minimum number of shares offered; and . We receive the final approval of the Office of Thrift Supervision to complete the conversion and offering. Citizens South Holdings, MHC intends to vote its ownership interest in favor of the conversion. At June 30, 2002, Citizens South Holdings, MHC owned 58.4% of the outstanding common stock of Citizens South Banking Corporation. In addition, as of August __, 2002, directors and executive officers of Citizens South Banking Corporation and their associates owned _______ shares of Citizens South Banking Corporation, or ___% of the outstanding shares. They intend to vote those shares in favor of the plan of conversion. Additional Information Our branch personnel may not, by law, assist with investment-related questions about the offering. If you have any questions regarding the conversion, please call the stock information center, toll free, at (___) ___-____, Monday through Friday between 9 a.m. and 5 p.m., North Carolina Time. TO ENSURE THAT EACH PERSON RECEIVES A PROSPECTUS AT LEAST 48 HOURS PRIOR TO THE EXPIRATION DATE OF SEPTEMBER 18, 2002 IN ACCORDANCE WITH FEDERAL LAW, NO PROSPECTUS WILL BE MAILED ANY LATER THAN FIVE DAYS PRIOR TO SEPTEMBER 18, 2002 OR HAND-DELIVERED ANY LATER THAN TWO DAYS PRIOR TO SEPTEMBER 18, 2002. 9 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA OF CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARY The following tables set forth selected consolidated historical financial and other data of Citizens South Banking Corporation for the years and at the dates indicated. On April 9, 1998, Citizens South Bank was reorganized from a mutual savings bank into a mutual holding company structure. Prior to that date, Citizens South Banking Corporation had no significant assets, liabilities or operations and, accordingly, the financial and other data prior to that date represents the consolidated financial condition and results of operations of Citizens South Bank. The information is derived in part from and should be read together with the audited consolidated financial statements and notes thereto of Citizens South Banking Corporation beginning at page F-2 of this prospectus. The information at September 30, 2000, 1999, 1998 and 1997 and for the years ended September 30, 1998 and 1997 was derived in part from audited consolidated financial statements which are not included in this prospectus. 10
At or For the Three At or For the Twelve Months Ended -------------------------------------------------------------------- Months Ended March 31, December 31, September 30, ---------------------- -------------------- -------------------------------------------- 2002 2001 2001 2000 2000 1999 1998 1997 ---------- --------- -------- -------- -------- -------- -------- -------- (Dollars in thousands, except per share data) Income Statement Data: Interest income ..................... $ 6,299 $ 4,335 $ 16,383 $ 16,834 $ 16,414 $ 15,238 $ 13,927 $ 12,936 Interest expense .................... 2,676 2,670 9,771 9,685 9,219 7,888 7,126 6,952 -------- -------- -------- -------- -------- -------- -------- -------- Net interest income ................. 3,623 1,665 6,612 7,149 7,195 7,350 6,801 5,984 Provision for loan losses ........... 65 30 120 53 30 105 300 293 -------- -------- -------- -------- -------- -------- -------- -------- Net interest income after provision for loan losses ................... 3,558 1,635 6,492 7,096 7,165 7,245 6,501 5,691 Noninterest income .................. 930 618 3,006 2,202 1,811 984 684 464 Noninterest expense ................. 3,034 1,502 7,082 6,102 5,961 6,259 4,567 3,956 Nonrecurring gain (loss) on sale of assets ............................ 88 (9) (10) (602) 257 1,389 272 52 -------- -------- -------- -------- -------- -------- -------- -------- Income before income taxes .......... 1,542 742 2,406 2,594 3,272 3,359 2,890 2,251 Income tax expense .................. 550 230 702 846 1,087 1,198 1,004 819 -------- -------- -------- -------- -------- -------- -------- -------- Net income ........................... $ 992 $ 512 $ 1,704 $ 1,748 $ 2,185 $ 2,161 $ 1,886 $ 1,432 Amortization of intangible assets, net of tax ......................... $ 236 -- -- -- -- -- -- -- -------- -------- -------- -------- -------- -------- -------- -------- Net cash earnings .................... $ 1,228 $ 512 $ 1,704 $ 1,748 $ 2,185 $ 2,161 $ 1,886 $ 1,432 ======== ======== ======== ======== ======== ======== ======== ======== Per Share Data (1): Basic net income .................... 0.24 0.13 $ 0.42 $ 0.43 $ 0.53 $ 0.50 N/A N/A Diluted net income .................. 0.24 0.13 0.42 0.43 0.53 0.50 N/A N/A Basic net cash earnings, excluding amortization of intangible assets . 0.30 0.13 0.42 0.43 0.53 0.50 N/A N/A Diluted net cash earnings, excluding amortization of intangible assets ................. 0.30 0.13 0.42 0.43 0.53 0.50 N/A N/A Cash dividends declared ............. 0.08 0.08 0.30 0.24 0.235 0.215 0.10 N/A Period-end book value ............... 10.03 9.62 9.89 9.42 9.31 9.09 9.24 N/A Balance Sheet Data: Total assets ....................... $443,285 $268,125 $447,581 $252,750 $244,651 $237,453 $208,003 $173,470 Loans receivable, net .............. 323,528 164,773 334,321 158,820 176,963 168,044 136,500 134,491 Mortgage-backed and related securities ........................ 23,007 28,032 25,405 22,955 19,772 19,992 14,707 10,087 Investment securities .............. 22,859 31,938 25,946 32,822 32,930 28,642 36,507 18,655 Deposits ........................... 352,082 180,406 353,692 167,931 161,352 159,425 143,900 145,444 Borrowings ......................... 41,009 44,393 42,057 42,737 40,606 35,500 19,500 3,500 Stockholder's equity ............... 42,237 40,526 41,630 39,763 39,287 39,709 41,570 20,868 Performance Ratios: Return on average assets ............ 0.89% 0.79% 0.65% 0.71% 0.90% 0.96% 0.98% 0.84% Return on average equity ............ 9.44 5.10 4.17 4.46 5.53 5.19 6.47 7.38 Return on average assets, excluding amortization of intangible assets . 1.11 0.79 0.65 0.71 0.90 0.96 0.98 0.84 Return on average equity, excluding amortization of intangible assets . 11.69 5.10 4.17 4.46 5.53 5.19 6.47 7.38 Average interest-earning assets to average interest-bearing liabilities ....................... 103.70 115.24 116.08 117.85 114.97 120.44 117.01 109.92 Noninterest expense to average total assets ...................... 2.73 2.33 2.70 2.85 2.45 2.78 2.38 2.31 Noninterest expense to average total assets, excluding amortization of intangible assets . 2.42 2.33 2.70 2.85 2.45 2.78 2.38 2.31 Interest rate spread ................ 3.50 2.07 2.05 2.34 2.53 2.65 3.16 3.24 Net interest margin ................. 3.26 2.57 2.52 2.92 2.96 3.27 3.54 3.50 Asset Quality Ratios: Allowance for loan losses to total loans at the end of period ........ 0.91% 0.89% 0.91% 0.95% 0.84% 0.86% 0.98% 0.80% Ratio of allowance for loan losses to nonperforming loans ............ 208.13% 404.79% 375.12% 326.93% 598.05% 1,605.32% 113.97% 104.82% Nonperforming loans to total loans .. 0.45 0.22 0.25 0.30 0.15 0.06 0.91 0.79 Nonperforming loans to total assets . 0.33 0.14 0.19 0.19 0.11 0.04 0.60 0.61 Capital Ratios: Average equity to average total assets ............................ 9.42% 15.46% 15.55% 16.02% 16.26% 18.51% 15.16% 11.34% Equity to assets at period end ...... 9.53 15.11 9.30 15.73 16.06 16.72 19.99 12.03 Dividend payout ratio (1) ........... 14.11 26.37 31.07 41.74 39.44 43.40 23.90 N/A Other Data: Number of outstanding loans ......... 7,320 3,665 7,534 3,801 3,760 4,368 3,498 3,164 Number of deposit accounts .......... 25,143 16,405 25,366 15,620 16,218 14,419 13,432 13,760 Number of full service offices ...... 9 6 9 5 5 4 4 4
______________ (1) Per share data and dividend payout ratios are not applicable for periods prior to the mutual holding company reorganization in April 1998. 11 RISK FACTORS You should consider carefully the following risk factors in evaluating an investment in the common stock. The Future Price of the Common Stock May be Less Than the Purchase Price in the Offering. We cannot assure you that if you purchase common stock in the offering you will be able to sell it later at or above the purchase price in the offering. The final aggregate purchase price of the common stock in the conversion will be based on an independent appraisal. The appraisal is not intended, and should not be construed, as a recommendation of any kind as to the advisability of purchasing shares of common stock. The valuation is based on estimates and projections of a number of matters, all of which are subject to change from time to time. Our Commercial Real Estate, Multi-Family and Commercial Business Loans Expose Us to Increased Lending Risks. At March 31, 2002, our portfolio of commercial real estate loans totaled $23.9 million, or 7.2% of total gross loans, our portfolio of commercial business loans totaled $31.2 million, or 9.4% of total gross loans, and our portfolio of multi-family loans totaled $9.0 million, or 2.7% of total gross loans. These types of loans generally expose a lender to greater risk of non-payment and loss than one-to four-family residential mortgage loans because repayment of the loans often depends on the successful operations and the income stream of the borrowers. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one-to four-family residential mortgage loans. Also, many of our borrowers have more than one commercial real estate or multi-family loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one-to four-family residential mortgage loan. If Our Allowance for Loan Losses is Not Sufficient to Cover Actual Loan Losses, Our Earnings Could Decrease. Our loan customers may not repay their loans according to their terms and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. We may experience significant loan losses, which could have a material adverse effect on our operating results. We make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover losses that have been incurred in our loan portfolio, resulting in additions to our allowance. In addition, the federal banking regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs could have a material adverse effect on our results of operations and financial condition. Changes in Interest Rates Could Adversely Affect Our Results of Operations and Financial Condition. Our results of operations and financial condition are significantly affected by changes in interest rates. Our results of operations depend substantially on our net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense paid on our interest-bearing liabilities. Because our interest-bearing liabilities generally reprice or mature more quickly than our interest-earning assets, an increase in interest rates generally would result in a decrease in our net interest income. Changes in interest rates also affect the value of our interest-earning assets, and in particular our securities portfolio. Generally, the value of securities fluctuates inversely with changes in interest rates. At March 31, 2002, our securities available for sale totaled $22.9 million. Unrealized gains and losses on securities available for sale are 12 reported as a separate component of stockholders' equity. Decreases in the fair value of securities available for sale, therefore, could have an adverse effect on stockholders' equity. We also are subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are unable to reinvest the cash received from such prepayments at rates that are comparable to the rates on existing loans and securities. Additionally, increases in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable rate loans. Our Ability To Grow May Be Limited If We Cannot Make Acquisitions. In an effort to fully deploy the capital we raise in the offering, and to increase our loan and deposit growth, we may seek to expand our banking franchise by acquiring other financial institutions or branches primarily in our market area. Our ability to grow through selective acquisitions of other financial institutions or branches will depend on successfully identifying, acquiring and integrating them. We cannot assure you that we will be able to identify attractive acquisition candidates, make acquisitions on favorable terms or successfully integrate any acquired institutions or branches into our banking organization. We currently have no specific plans, arrangements or understandings regarding any such expansions or acquisitions. Our Return on Stockholders' Equity Will Be Reduced as a Result of the Offering. Net income divided by average stockholders' equity, known as "return on equity," is a ratio many investors use to compare the performance of a financial institution to its peers. We expect our return on equity to decrease as compared to our performance in recent years until we are able to leverage the additional capital raised in the offering. Until we can increase our net interest income and non-interest income, we expect our return on equity to be below the industry average, which may negatively impact the value of our common stock. The Implementation of Stock-Based Benefit Plans May Dilute Your Ownership Interest. We intend to adopt a stock option plan and recognition and retention plan following the offering. These stock benefit plans will be funded either through open market purchases, if permitted, or from the issuance of authorized but unissued shares. While our intention is to fund these plans through open market purchases, stockholders will experience a reduction or dilution in ownership interest of 7.6% in the event newly issued shares are used to fund stock options and stock awards made under the recognition and retention plan. Our Recognition and Retention Plan Will Increase Our Costs, Which Will Reduce Our Profitability and Stockholders' Equity. We intend to implement a recognition and retention plan after the offering. Under this plan, our officers and directors may be awarded, at no cost to them, shares of common stock in an aggregate amount equal to 4% of the shares sold in the offering. We must recognize expense for shares awarded over their vesting period at the fair market value of the shares on the date they are awarded. The recognition and retention plan may not be implemented until at least six months after the offering. If the plan is adopted within twelve months after the offering, it is subject to Office of Thrift Supervision regulations. Assuming the shares of common stock to be awarded under the plan are repurchased in the open market and cost the same as the purchase price in the offering, the reduction to stockholders' equity from the plan would be between $1.4 million at the minimum of the offering range and $2.1 million at the adjusted maximum of the offering range. Strong Competition Within Our Market Area May Limit Our Growth and Profitability. Competition in the banking and financial services industry is intense. We compete in our market area with commercial banks, savings institutions, mortgage banks, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms. Many of these competitors have substantially greater 13 resources and lending limits than we have and may offer certain services that we do not provide. Our profitability depends upon our continued ability to successfully compete in our market area. We Have Broad Discretion in Allocating the Proceeds of the Offering. Our Failure to Effectively Utilize Such Proceeds Could Reduce Our Profitability. Citizens South Banking Corporation intends to contribute approximately 50% of the net proceeds of the offering to Citizens South Bank. Citizens South Banking Corporation may use the remaining net proceeds to finance the acquisition of other financial institutions, pay dividends to stockholders, repurchase common stock, purchase investment securities, or for other general corporate purposes. Citizens South Banking Corporation expects to use a portion of the net proceeds to fund the employee stock ownership plan purchases of shares in the offering. Citizens South Bank may use the proceeds it receives to establish or acquire new branches, acquire financial institutions, fund new loans, purchase investment securities, or for general corporate purposes. We have not allocated specific amounts of proceeds for any of these purposes, and we will have significant flexibility in determining how much of the net proceeds we apply to different uses and the timing of such applications. Our failure to utilize these funds effectively could reduce our profitability. We Operate in a Highly Regulated Environment and We May be Adversely Affected by Changes in Laws and Regulations. We are subject to extensive regulation, supervision and examination by the Office of Thrift Supervision, our chartering authority, and by the Federal Deposit Insurance Corporation, as insurer of our deposits. As a savings and loan holding company, Citizens South Banking Corporation is subject to regulation and supervision by the Office of Thrift Supervision. Such regulation and supervision govern the activities in which an institution and its holding company may engage, and are intended primarily for the protection of the insurance fund and depositors. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and determination of the level of an institution's allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations or legislation, may have a material impact on our operations. Once Submitted, Your Purchase Order May Not be Revoked Unless the Stock Offering is Terminated or Extended Beyond November 2, 2002. Funds submitted in connection with the purchase of common stock in the offering will be held by Citizens South Banking Corporation until the termination or completion of the offering, including any extension of the expiration date. Because completion of the offering will be subject to an update of the independent appraisal and other factors, there may be one or more delays in completing the offering. Orders submitted in the offering are irrevocable, and subscribers will have no access to subscription funds and/or shares of common stock unless the stock offering is terminated, or extended beyond November 2, 2002. Various Factors May Make Takeover Attempts More Difficult to Achieve. Our board of directors has no current intention to sell control of Citizens South Banking Corporation. Provisions of our certificate of incorporation and bylaws, federal and state regulations and various other factors may make it more difficult for companies or persons to acquire control of Citizens South Banking Corporation without the consent of our board of directors. It is possible, however, that you would want a takeover attempt to succeed because, for example, a potential acquiror could offer a premium over the then prevailing price of our common stock. The factors that may discourage takeover attempts or make them more difficult include: . Office of Thrift Supervision regulations. Office of Thrift Supervision regulations prohibit, for three years following the completion of a mutual-to-stock conversion, the acquisition of more than 10% of any class of equity security of a converted institution without the prior approval of the Office of Thrift Supervision. The charter of Citizens South Bank also will include a provision for a period of five years after the conversion, that prohibits any person from acquiring or offering to acquire, directly or indirectly, more than 10% of any class of equity security of Citizens South Bank. 14 . Certificate of incorporation and statutory provisions. Provisions of the certificate of incorporation and bylaws of Citizens South Banking Corporation and the corporate law of the State of Delaware, may make it more difficult and expensive to pursue a takeover attempt that management opposes. These provisions also make more difficult the removal of our current board of directors or management, or the appointment of new directors. These provisions include: limitations on voting rights of beneficial owners of more than 10% of our common stock; supermajority voting requirements for certain business combinations; and the election of directors to staggered terms of three years. Our bylaws also contain provisions regarding the timing and content of stockholder proposals and nominations and qualification for service on the board of directors. . Required change in control payments. We have entered into employment agreements and change of control agreements with certain executive officers that will require payments to be made to them in the event their employment is terminated following a change in control of Citizens South Banking Corporation or Citizens South Bank. These payments may have the effect of increasing the costs of acquiring Citizens South Banking Corporation, thereby discouraging future attempts. 15 FORWARD-LOOKING STATEMENTS This prospectus contains forward-looking statements, which can be identified by the use of such words as estimate, project, believe, intend, anticipate, plan, seek, expect and similar expressions. These forward-looking statements include: . statements of our goals, intentions and expectations; . statements regarding our business plans, prospects, growth and operating strategies; . statements regarding the asset quality of our loan and investment portfolios; and . estimates of our risks and future costs and benefits. These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following important factors that could affect the actual outcome of future events: . general economic conditions, either nationally or in our market areas, that are worse than expected; . significantly increased competition among depository and other financial institutions; . inflation and changes in the interest rate environment that reduce our margins or reduce the fair value of financial instruments; . adverse changes in the securities markets; . legislative or regulatory changes that adversely affect our business; . our ability to enter new markets successfully and capitalize on growth opportunities; . changes in consumer spending, borrowing and savings habits; . changes in accounting policies and practices, as may be adopted by the bank regulatory agencies and the Financial Accounting Standards Board; and . changes in our organization, compensation and benefit plans. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. We discuss some of these uncertainties and others in "Risk Factors" beginning on page __. HOW WE INTEND TO USE THE PROCEEDS FROM THE OFFERING Although we cannot determine what the actual net proceeds from the sale of the common stock in the offering will be until the offering is completed, we anticipate that the net proceeds will be between $33.0 million and $44.8 million, or $51.6 million if the offering range is increased by 15%. Citizens South Banking Corporation estimates that it will invest in Citizens South Bank between $16.5 million and $22.4 million, or $25.8 million if the offering range is increased by 15%. Citizens South Banking Corporation intends to retain approximately 50% of the net proceeds. 16 A summary of the anticipated net proceeds at the minimum, midpoint, maximum and adjusted maximum of the offering range and anticipated distribution of the net proceeds is as follows:
Adjusted Minimum Midpoint Maximum Maximum -------------- -------------- -------------- -------------- Offering proceeds.......................... $ 34,000,000 $ 40,000,000 $ 46,000,000 $ 52,900,000 Less offering expenses..................... 1,010,250 1,089,630 1,169,010 1,260,297 -------------- -------------- -------------- -------------- Net offering proceeds................... $ 32,989,750 $ 38,910,370 $ 44,830,990 $ 51,639,703 ============== ============== ============== ============== Distribution of net proceeds: To Citizens South Bank.................. $ 16,494,875 $ 19,455,185 $ 22,415,495 $ 25,819,851 Retained by Citizens South Banking Corporation........................... $ 16,494,875 $ 19,455,185 $ 22,415,495 $ 25,819,851
Payments for shares made through withdrawals from existing deposit accounts will not result in the receipt of new funds for investment but will result in a reduction of Citizens South Bank's deposits. The net proceeds may vary because total expenses relating to the offering may be more or less than our estimates. For example, our expenses would increase if a syndicated community offering were used to sell shares not purchased in the subscription offering and community offering. Citizens South Banking Corporation May Use the Proceeds it Retains From the Offering: . to finance the acquisition of financial institutions or branches or other financial service companies, although we do not now have any specific acquisition or expansion plans; . to pay cash dividends to stockholders; . to repurchase its common stock; . to invest in securities; and . for other general corporate purposes. Under current Office of Thrift Supervision regulations, we may not repurchase shares of our common stock during the first year following the conversion, except when extraordinary circumstances exist and with prior regulatory approval. Citizens South Bank May Use the Proceeds it Receives From the Offering: . to fund new loans, including single-family mortgage loans, multi-family residential and commercial mortgage loans, commercial business loans, construction loans and consumer loans; . to expand its retail banking franchise, by establishing or acquiring new branches or by acquiring other financial institutions, or other financial service companies, although we do not now have any specific acquisition or expansion plans; . to support new products and services; . to invest in securities; and . for other general corporate purposes. 17 OUR DIVIDEND POLICY Citizens South Banking Corporation currently pays a cash dividend of $0.08 per share per quarter, or $0.32 per share per year. After the conversion, we intend to continue to pay cash dividends on a quarterly basis. We expect such dividends to equal $0.23, $0.20, $0.17 and $0.15 per share per year at the minimum, midpoint, maximum and adjusted maximum of the offering range, respectively, which represents an annual dividend yield of 2.3%, 2.0%, 1.7% and 1.5% at the minimum, midpoint, maximum and adjusted maximum of the offering range, respectively, based upon a stock price of $10.00 per share. The amount of dividends that we intend to pay to our stockholders following the conversion is intended to preserve the per share dividend amount, adjusted to reflect the exchange ratio, that our stockholders currently receive on their Citizens South Banking Corporation common stock. The dividend rate and the continued payment of dividends will depend on a number of factors including our capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic conditions. We cannot assure you that we will not reduce or eliminate dividends in the future. Under the rules of the Office of Thrift Supervision, Citizens South Bank will not be permitted to pay dividends on its capital stock to Citizens South Banking Corporation, its sole stockholder, if Citizens South Bank's stockholder's equity would be reduced below the amount of the liquidation account. See "The Conversion--Liquidation Rights." For information concerning federal and state law and regulations regarding the ability of Citizens South Bank to make capital distributions, including the payment of dividends, to Citizens South Banking Corporation, see "Taxation--Federal Taxation" and "Supervision and Regulation--Federal Banking Regulation." Unlike Citizens South Bank, Citizens South Banking Corporation is not restricted by Office of Thrift Supervision regulations on the payment of dividends to its stockholders, although the source of dividends will depend on the net proceeds retained by Citizens South Banking Corporation and earnings thereon, and upon dividends from Citizens South Bank. Citizens South Banking Corporation, however, is subject to the requirements of Delaware law, which generally limits dividends to an amount equal to the excess of its stockholders' equity over its statutory capital or, if there is no excess, to its net earnings for the current and/or immediately preceding fiscal year. Additionally, we have committed to the Office of Thrift Supervision that during the one-year period following the completion of the conversion, Citizens South Banking Corporation will not take any action to declare an extraordinary dividend to our stockholders that would be treated by such stockholders as a tax-free return of capital for federal income tax purposes, without prior approval of the Office of Thrift Supervision. MARKET FOR THE COMMON STOCK Citizens South Banking Corporation common stock is currently listed on the Nasdaq National Market under the symbol "CSBC," and there is an established market for such common stock. At August __, 2002, we had _____________ market makers, including Keefe, Bruyette & Woods, Inc. Upon completion of the conversion, the new shares of common stock of Citizens South Banking Corporation will replace existing shares and be traded on the Nasdaq National Market. Keefe, Bruyette & Woods, Inc. intends to remain a market maker in Citizens South Banking Corporation common stock following the conversion. Keefe, Bruyette & Woods, Inc. also will assist Citizens South Banking Corporation in obtaining other market makers after the conversion. We cannot assure you that other market makers will be obtained or that an active and liquid trading market for the common stock will develop or, if developed, will be maintained. For a period of 20 trading days following completion of our offering, our symbol will be "CSBCD," after which it will be "CSBC." The development of a public market having the desirable characteristics of depth, liquidity and orderliness depends on the existence of willing buyers and sellers, the presence of which is not within our control or that of any market maker. The number of active buyers and sellers of our common stock at any particular time may be limited, which may have an adverse effect on the price at which our common stock can be sold. There can be no assurance that persons purchasing the common stock will be able to sell their shares at or above the $10.00 price per share in the offering. Purchasers of our common stock should have a long-term investment intent and should recognize that there may be a limited trading market in the common stock. 18 The following table sets forth the high and low trading prices for Citizens South Banking Corporation common stock and cash dividends paid per share for the periods indicated. As of March 31, 2002, there were 1,752,427 publicly held shares of Citizens South Banking Corporation common stock issued and outstanding. In connection with the conversion, each existing share of common stock of Citizens South Banking Corporation will be converted into a number of new shares of common stock, based upon the exchange ratio that is described in other parts of this prospectus.
Year Ending Dividend Paid December 31, 2002 High Low Per Share ----------------- ------------------ -------------- ----------------------------- Second quarter $[ ] $[ ] $[ ] First quarter 16.550 14.250 0.080 Year Ended Dividend Paid December 31, 2001 High Low Per Share ----------------- ------------------ -------------- ----------------------------- Fourth quarter $ 16.120 $ 14.500 $ 0.075 Third quarter 16.310 12.350 0.075 Second quarter 12.760 11.700 0.075 First quarter 12.190 10.940 0.075 Year Ended Dividend Paid December 31, 2000 High Low Per Share ----------------- ------------------ -------------- ----------------------------- Fourth quarter $ 11.063 $ 10.375 $ 0.060 Third quarter 10.938 10.000 0.060 Second quarter 11.313 10.375 0.060 First quarter 11.875 11.125 0.060
On May 21, 2002, the business day immediately preceding the public announcement of the conversion, and on August __, 2002, the closing prices of Citizens South Banking Corporation common stock as reported on the Nasdaq National Market were $18.00 per share and $_____ per share, respectively. At August __, 2002, Citizens South Banking Corporation had approximately _____ stockholders of record. On the effective date of the conversion, all publicly held shares of Citizens South Banking Corporation common stock, including shares held by our officers and directors, will be converted automatically into and become the right to receive a number of shares of Citizens South Banking Corporation common stock determined pursuant to the exchange ratio. See "The Conversion - Share Exchange Ratio." Options to purchase shares of Citizens South Banking Corporation common stock will be converted into options to purchase a number of shares of Citizens South Banking Corporation common stock determined pursuant to the exchange ratio, for the same aggregate exercise price. See "Beneficial Ownership of Common Stock." 19 HISTORICAL AND PRO FORMA REGULATORY CAPITAL COMPLIANCE At March 31, 2002, Citizens South Bank exceeded all of the applicable regulatory capital requirements. The table below sets forth the historical equity capital and regulatory capital of Citizens South Bank at March 31, 2002 and the pro forma regulatory capital of Citizens South Bank, assuming the indicated number of shares were sold as of such date at $10.00 per share and Citizens South Bank received 50% of the net conversion proceeds.
Citizens South Bank Pro Forma at March 31, 2002 --------------------------------------------------------------------------- Historical at March 31, Maximum as Adjusted 2002 Minimum Midpoint Maximum (1) ----------------------- ----------------- ----------------- ------------------ ------------------- Percent Percent Percent Percent Percent of Assets of Assets of Assets of Assets of Assets Amount (2) Amount (2) Amount (2) Amount (2) Amount (2) ---------- ---------- ------- --------- ------- --------- -------- --------- -------- -------- (Dollars in Thousands) Equity capital ................. $ 33,499 7.61% $ 50,013 10.95% $ 52,973 11.52% $ 55,934 12.09% $ 59,338 12.73% Tangible capital ............... $ 28,217 6.50 $ 44,731 9.92 $ 47,691 10.51 50,652 11.09 54,056 11.74 Tangible requirement ........... 6,516 1.50 6,764 1.50 6,808 1.50 6,853 1.50 6,904 1.50 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Excess ......................... $ 21,701 5.00% $ 37,967 8.42% $ 40,883 9.01% $ 43,799 9.59% $ 47,152 10.24% ======== ====== ======== ====== ======== ====== ======== ====== ======== ====== Core (leverage) capital ........ $ 28,217 6.50% $ 44,731 9.92% $ 47,691 10.51% $ 50,652 11.09% $ 54,056 11.74% Core (leverage) requirement(3).. 17,377 4.00 18,037 4.00 18,156 4.00 18,274 4.00 18,410 4.00 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Excess ......................... $ 10,840 2.50% $ 26,694 5.92% $ 29,535 6.51% $ 32,378 7.09% $ 35,646 7.74% ======== ====== ======== ====== ======== ====== ======== ====== ======== ====== Total risk-based capital(4) .... $ 31,778 10.48% $ 48,292 15.50% $ 51,252 16.37% $ 54,213 17.23% $ 57,617 18.22% Risk-based requirement ......... 24,267 8.00 24,928 8.00 25,046 8.00 25,165 8.00 25,301 8.00 -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ Excess ......................... $ 7,511 2.48% $ 23,364 7.50% $ 26,206 8.37% $ 29,048 9.23% $ 32,316 10.22% ======== ====== ======== ====== ======== ====== ======== ====== ======== ======
___________________ (1) As adjusted to give effect to an increase in the n umber of shares which could occur due to a 15% increase in the offering range to reflect changes in market or general financial conditions following the commencement of the offering. (2) Tangible and core capital levels are shown as a percentage of total adjusted assets. Risk-based capital levels are shown as a percentage of risk-weighted assets. (3) The current Office of Thrift Supervision core capital requirement for financial institutions is 3% of total adjusted assets for financial institutions that receive the highest supervisory rating for safety and soundness and a 4% to 5% core capital ratio requirement for all other financial institutions. (4) Pro forma amounts and percentages assume net proceeds are invested in assets that carry a 50% risk-weighting. 20 CAPITALIZATION The following table presents the historical consolidated capitalization of Citizens South Banking Corporation at March 31, 2002 and the pro forma consolidated capitalization of Citizens South Banking Corporation after giving effect to the conversion, based upon the assumptions set forth in the "Pro Forma Data" section.
9,063,021 5,825,004 6,852,946 7,880,880 Maximum as Citizens Minimum Midpoint Maximum Adjusted South Shares Shares Shares Shares Banking Outstanding, Outstanding, Outstanding, Outstanding, Corporation 3,400,000 4,000,000 4,600,000 5,290,000 Historical Shares Sold Shares Sold Shares Sold Shares Sold at March 31, at $10.00 Per at $10.00 at $10.00 Per at $10.00 2002 Share per Share Share Per Share (1) ------------ ------------- ------------ ------------- ------------- (Dollars in Thousands) Deposits (2) ........................... $ 352,082 352,082 $ 352,082 352,082 352,082 Borrowed funds ......................... 41,009 41,009 41,009 41,009 41,009 ------------ ------------ ------------ ------------ ------------ Total deposits and borrowed funds ............................ $ 393,091 $ 393,091 $ 393,091 $ 393,091 $ 393,091 ============ ============ ============ ============ ============ Stockholders' equity: Preferred stock, $0.01 par value, 1,000,000 shares authorized (post-conversion) (3) ................ -- -- -- -- -- Common stock $0.01 par value, 20,000,000 shares authorized (post-conversion); shares to be issued as reflected (3)(4) ........... 4,581 58 69 79 91 Additional paid-in capital (3) ........ 16,843 54,375 60,284 66,195 72,992 Retained earnings (5) ................. 25,957 25,957 25,957 25,957 25,957 Accumulated other comprehensive income ............................... 843 843 843 843 843 Less: Treasury stock ........................ (4,776) (4,776) (4,776) (4,776) (4,776) Common stock held by employee stock ownership plan ................. (1,211) (1,211) (1,211) (1,211) (1,211) Common stock to be acquired by employee stock ownership plan (6) .... -- (680) (800) (920) (1,058) Common stock to be acquired by recognition and retention plan (7) ... -- (1,360) (1,600) (1,840) (2,116) ------------ ------------ ------------ ------------ ------------ Total stockholders' equity ......... $ 42,237 $ 73,206 $ 78,766 $ 84,328 $ 90,722 ============ ============ ============ ============ ============ Total stockholders' equity as a percentage of total assets ....... 9.53% 15.44% 16.42% 17.37% 18.45% Tangible stockholders' equity as a percentage of total assets ........................... 7.47% 13.52% 14.52% 15.50% 16.60%
____________________________ (1) As adjusted to give effect to an increase in the number of shares which could occur due to a 15% increase in the offering range to reflect changes in market or general financial conditions following the commencement of the subscription and community offerings. (2) Does not reflect withdrawals from deposit accounts for the purchase of common stock in the conversion. These withdrawals would reduce pro forma deposits by the amount of the withdrawals. (3) Citizens South Banking Corporation has 10,000,000 authorized shares of preferred stock and 20,000,000 authorized shares of common stock, par value $1.00 per share. Pro forma Citizens South Banking Corporation common stock and additional paid-in capital have been increased to reflect the number of shares of Citizens South Banking Corporation common stock to be outstanding. Pro forma additional paid-in capital reflects consolidation of $19,000 of capital from Citizens South Holdings, MHC. (4) No effect has been given to the issuance of additional shares of Citizens South Banking Corporation common stock pursuant to an additional stock option plan. If this plan is implemented, an amount equal to 10% of the shares of Citizens South Banking Corporation common stock sold in the offering will be reserved for issuance upon the exercise of options under the stock option plan. No effect has been given to the exercise of options currently outstanding. See "Management of Citizens South Banking Corporation-Stock Benefit Plans." (5) The retained earnings of Citizens South Bank will be substantially restricted after the conversion. See "The Conversion-Liquidation Rights" and "Supervision and Regulation-Federal Banking Regulation." (footnotes continued on following page) 21 ______________________________________ (6) Assumes that 2% of the shares sold in the offering will be acquired by the employee stock ownership plan financed by a loan from Citizens South Banking Corporation. The loan will be repaid principally from Citizens South Bank's contributions to the employee stock ownership plan. Since Citizens South Banking Corporation will finance the employee stock ownership plan debt, this debt will be eliminated through consolidation and no liability will be reflected on Citizens South Banking Corporation's consolidated financial statements. Accordingly, the amount of stock acquired by the employee stock ownership plan is shown in this table as a reduction of total stockholders' equity. (7) Assumes a number of shares of common stock equal to 4% of the common stock to be sold in the offering will be purchased by the stock recognition and retention plan in open market purchases. The dollar amount of common stock to be purchased is based on the $10.00 per share subscription price in the offering and represents unearned compensation. This amount does not reflect possible increases or decreases in the value of stock relative to the subscription price in the offering. As Citizens South Banking Corporation accrues compensation expense to reflect the vesting of shares pursuant to the stock recognition and retention plan, the credit to capital will be offset by a charge to operations. Implementation of the stock recognition and retention plan will require stockholder approval. If the shares to fund the plan are assumed to come from authorized but unissued shares of Citizens South Banking Corporation, the number of outstanding shares at the minimum, midpoint, maximum and the maximum, as adjusted, of the offering range would be 5,961,004, 7,012,946, 8,064,888 and 9,274,621, respectively, total stockholders' equity would be $74.6 million, $80.4 million, $86.2 million and $92.8 million, respectively, and total stockholders' ownership in Citizens South Banking Corporation would be diluted by approximately 2.3%. PRO FORMA DATA The following table summarizes historical data of Citizens South Banking Corporation and pro forma data of Citizens South Banking Corporation at or for the three months ended March 31, 2002 and the year ended December 31, 2001, based on assumptions set forth below and in the table, and should not be used as a basis for projections of market value of the common stock following the conversion. No effect has been given in the table to the possible issuance of additional shares pursuant to the current outstanding stock option plan or for the possible issuance of additional shares pursuant to any stock option plan or stock recognition and retention plan that may be adopted by our stockholders no earlier than six months after the conversion. Moreover, pro forma stockholders' equity per share does not give effect to the liquidation account to be established in the conversion or, in the event of a liquidation of Citizens South Bank, to the tax effect of the recapture of the bad debt reserve. See "The Conversion-Liquidation Rights." Pro forma consolidated net earnings of Citizens South Banking Corporation for the three months ended March 31, 2002 and the year ended December 31, 2001 has been calculated as if the estimated net proceeds received by Citizens South Banking Corporation and Citizens South Bank had been invested at an assumed interest rate of 4.36% (2.79% on an after-tax basis) for the three months ended March 31, 2002 and 5.52% (3.53% on an after-tax basis) for the year ended December 31, 2001. The reinvestment rate was calculated based on the arithmetic average of Citizens South Banking Corporation's average yield on interest-earning assets and average rate paid on interest-bearing deposits for the three months ended March 31, 2002 and the year ended December 31, 2001. The effect of withdrawals from deposit accounts for the purchase of common stock has not been reflected. Historical and pro forma per share amounts have been calculated by dividing historical and pro forma amounts by the indicated number of shares of common stock. No effect has been given in the pro forma stockholders' equity calculations for the assumed earnings on the net proceeds. It is assumed that Citizens South Banking Corporation will retain 50% of the estimated net conversion proceeds. The actual net proceeds from the sale of common stock will not be determined until the conversion is completed. However, we currently estimate the net proceeds to be between $33.0 million and $44.8 million, or $51.6 million if the offering range is increased by 15%. It is assumed that all shares will be sold in the subscription offering and community offering. The following pro forma information may not be representative of the financial effects of the foregoing transactions at the dates on which such transactions actually occur, and should not be taken as indicative of future results of operations. Pro forma consolidated stockholders' equity represents the difference between the stated amounts of assets and liabilities of Citizens South Banking Corporation. The pro forma stockholders' equity is not intended to represent the fair market value of the common stock. 22
At or For the Three Months Ended March 31, 2002 Based upon the Sale at $10.00 Per Share of ----------------------------------------------------------- 5,290,000 3,400,000 4,000,000 4,600,000 Shares (1) Shares Shares Shares 15% Above Minimum of Midpoint of Maximum of Maximum of Estimated Estimated Estimated Estimated Price Range Price Range Price Range Price Range ------------ ------------ ------------ ------------ (Dollars in Thousands, Except Per Share Amounts) Gross proceeds..................................................... $ 34,000 40,000 $ 46,000 $ 52,900 Expenses........................................................... 1,010 1,090 1,169 1,260 ------------ ------------ ------------ ------------ Estimated net proceeds.......................................... 32,990 38,910 44,831 51,640 Common stock acquired by employee stock ownership plan (7)......... (680) (800) (920) (1,058) Common stock acquired by recognition and retention plan (2)........ (1,360) (1,600) (1,840) (2,116) Assets received from the MHC....................................... 19 19 19 19 ------------ ------------ ------------ ------------ Estimated net proceeds, as adjusted............................. $ 30,969 $ 36,529 $ 42,090 $ 48,485 For the three months ended March 31, 2002 - ----------------------------------------- Consolidated net earnings: Historical...................................................... $ 992 $ 992 $ 992 $ 992 Pro forma adjustments: Income on adjusted net proceeds................................. 216 255 294 338 Recognition and retention plan (2).............................. (44) (51) (59) (68) Employee stock ownership plan (7)............................... (7) (9) (10) (11) ------------ ------------ ------------ ------------ Pro forma net earnings........................................ $ 1,157 $ 1,187 $ 1,217 $ 1,251 ============ ============ ============ ============ Earnings per share (3): Historical...................................................... $ 0.17 $ 0.15 $ 0.13 $ 0.11 Pro forma adjustments: Income on adjusted net proceeds................................. 0.04 0.04 0.04 0.04 Employee stock ownership plan (7)............................... -- -- -- -- Recognition and retention plan (2).............................. (0.01) (0.01) (0.01) (0.01) ------------ ------------ ------------ ------------ Pro forma earnings per share (3) (4).......................... $ 0.20 $ 0.18 $ 0.16 $ 0.14 ============ ============ ============ ============ Pro forma price to earnings........................................ 12.50x 13.89x 15.63x 17.86x Number of shares used in earnings per share calculations .......... 5,758,136 6,774,279 7,790,420 8,958,983 At March 31, 2002 - ----------------- Stockholders' equity: Historical...................................................... $ 42,237 $ 42,237 $ 42,237 $ 42,237 Estimated net proceeds.......................................... 32,990 38,910 44,831 51,640 MHC capital consolidation....................................... 19 19 19 19 Common stock acquired by employee stock ownership plan (7)...... (680) (800) (920) (1,058) Common stock acquired by recognition and retention plan (2)..... (1,360) (1,600) (1,840) (2,116) ------------ ------------ ------------ ------------ Pro forma stockholders' equity (5).......................... 73,206 78,766 84,328 90,722 Intangible assets............................................... (9,109) (9,109) (9,109) (9,109) ------------ ------------ ------------ ------------ Pro forma tangible stockholders' equity..................... $ 64,097 $ 69,657 $ 75,219 $ 81,613 ============ ============ ============ ============ Stockholders' equity per share (6): Historical...................................................... $ 7.25 $ 6.16 $ 5.36 $ 4.66 Estimated net proceeds.......................................... 5.67 5.68 5.69 5.70 Common stock acquired by employee stock ownership plan (7)...... (0.12) (0.12) (0.12) (0.12) Common stock acquired by recognition and retention plan (2)..... (0.23) (0.23) (0.23) (0.23) ------------ ------------ ------------ ------------ Pro forma stockholders' equity per share (5) (6)............ $ 12.57 $ 11.49 $ 10.70 $ 10.01 ============ ============ ============ ============ Pro forma tangible stockholders' equity per share........... $ 11.00 $ 10.16 $ 9.54 $ 9.01 ============ ============ ============ ============ Offering price as percentage of pro forma stockholders' equity per share................................................ 79.55% 87.03% 93.46% 99.90% Offering price as percentage of pro forma tangible stockholders' equity per share.................................. 90.91% 98.43% 104.82% 110.99% Number of shares used in book value per share calculations......... 5,825,004 6,852,946 7,880,888 9,063,021
(footnotes on next page) 23 ___________________________________ (1) As adjusted to give effect to an increase in the number of shares which could occur due to a 15% increase in the offering range to reflect changes in market and financial conditions following the commencement of the offering. (2) If approved by Citizens South Banking Corporation's stockholders, the stock recognition and retention plan intends to purchase an aggregate number of shares of common stock equal to 4% of the shares to be sold in the offering. Stockholder approval of the stock recognition and retention plan and purchases by the plan may not occur earlier than six months after the completion of the conversion. The shares may be acquired directly from Citizens South Banking Corporation or through open market purchases. The funds to be used by the stock recognition and retention plan to purchase the shares will be provided by Citizens South Banking Corporation. The table assumes that (i) the stock recognition and retention plan acquires the shares through open market purchases at $10.00 per share, (ii) 20% of the amount contributed to the stock recognition and retention plan is amortized as an expense during the three months ended March 31, 2002 and (iii) the stock recognition and retention plan expense reflects an effective combined federal and state tax rate of 36.0%. Assuming stockholder approval of the plan and that the plan shares are awarded through the use of authorized but unissued shares of common stock, stockholders would have their voting interests diluted by approximately 2.3%. (3) Per share figures include publicly held shares of Citizens South Banking Corporation common stock that will be exchanged for new shares of Citizens South Banking Corporation common stock in the conversion. See "The Conversion - Share Exchange Ratio." Net income per share computations are determined by taking the number of shares assumed to be sold in the offering and the number of new shares assumed to be issued in exchange for publicly held shares and, in accordance with Statement of Position 93-6, subtracting the recognition and retention plan shares and the employee stock ownership plan shares which have not been committed for release during the respective periods. See note 2 above. The number of shares of common stock actually sold and the corresponding number of exchange shares may be more or less than the assumed amounts. (4) No effect has been given to the issuance of additional shares of common stock pursuant to the stock option plan, which is expected to be adopted by Citizens South Banking Corporation following the offering and presented to stockholders for approval not earlier than six months after the completion of the conversion. If the stock option plan is approved by stockholders, a number of shares equal to 10% of the shares sold in the offering will be reserved for future issuance upon the exercise of options to be granted under the stock option plan. The issuance of authorized but previously unissued shares of common stock pursuant to the exercise of options under such plan would dilute existing stockholders' interests by approximately 5.5%. (5) The retained earnings of Citizens South Bank will be substantially restricted after the conversion. See "Our Dividend Policy," "The Conversion-Liquidation Rights" and "Supervision and Regulation-Federal Banking Regulation-Capital Distributions." (6) Per share figures include publicly held shares of Citizens South Banking Corporation common stock that will be exchanged for new shares of Citizens South Banking Corporation common stock in the conversion. Stockholders' equity per share calculations are based upon the sum of (i) the number of subscription shares assumed to be sold in the offering and (ii) new shares to be issued in exchange for publicly held shares at the minimum, midpoint, maximum and adjusted maximum of the offering range, respectively. The exchange shares reflect an exchange ratio of 1.3838, 1.6280, 1.8722 and 2.1530, respectively, at the minimum, midpoint, maximum and adjusted maximum of the offering range, respectively. The number of subscription shares actually sold and the corresponding number of exchange shares may be more or less than the assumed amounts. (7) Assumes that 2% of shares of common stock sold in the offering will be purchased by the employee stock ownership plan. For purposes of this table, the funds used to acquire these shares are assumed to have been borrowed by the employee stock ownership plan from the net proceeds of the offering retained by Citizens South Banking Corporation. Citizens South Bank intends to make annual contributions to the employee stock ownership plan in an amount at least equal to the principal of the debt. Citizens South Bank's total annual payments on the employee stock ownership plan debt are based upon 15 equal annual installments of principal and interest. Statement of Position 93-6 requires that an employer record compensation expense in an amount equal to the fair value of the shares committed to be released to employees. The pro forma adjustments assume that the employee stock ownership plan shares are allocated in equal annual installments based on the number of loan repayment installments assumed to be paid by Citizens South Bank, the fair value of the common stock remains that the subscription price and the employee stock ownership plan expense reflects an effective combined federal and state tax rate of 36.0%. The unallocated employee stock ownership plan shares are reflected as a reduction of stockholders' equity. No reinvestment is assumed on proceeds contributed to fund the employee stock ownership plan. The pro forma net income further assumes (i) that 1,133, 1,333, 1,533 and 1,763 shares were committed to be released during the period at the minimum, mid-point, maximum, and adjusted maximum of the offering range, respectively, and (ii) in accordance with Statement of Position 93-6, only the employee stock ownership plan shares committed to be released during the period were considered outstanding for purposes of net income per share calculations. 24
At or For the Year Ended December 31, 2001 Based upon the Sale at $10.00 Per Share of ------------------------------------------------------------- 5,290,000 3,400,000 4,000,000 4,600,000 Shares (1) Shares Shares Shares 15% Above Minimum of Midpoint of Maximum of Maximum of Estimated Estimated Estimated Estimated Price Range Price Range Price Range Price Range ------------ ------------ ------------ ------------ (Dollars in Thousands, Except Per Share Amounts) Gross proceeds.................................................... $ 34,000 $ 40,000 $ 46,000 $ 52,900 Expenses.......................................................... 1,010 1,090 1,169 1,260 ------------ ------------ ------------ ------------ Estimated net proceeds......................................... 32,990 38,910 44,831 51,640 Common stock acquired by employee stock ownership plan (7)........ (680) (800) (920) (1,058) Common stock acquired by recognition and retention plan (2)....... (1,360) (1,600) (1,840) (2,116) Assets received from the MHC...................................... 26 26 26 26 ------------ ------------ ------------ ------------ Estimated net proceeds, as adjusted............................ $ 30,976 $ 36,536 $ 42,097 $ 48,492 For the year ended December 31, 2001 (8) - ---------------------------------------- Consolidated net earnings: Historical..................................................... $ 1,704 $ 1,704 $ 1,704 $ 1,704 Pro forma adjustments: Income on adjusted net proceeds................................ 1,094 1,291 1,487 1,713 Recognition and retention plan (2)............................. (174) (205) (236) (271) Employee stock ownership plan (7).............................. (29) (34) (39) (45) ------------ ------------ ------------ ------------ Pro forma net earnings....................................... $ 2,595 $ 2,756 $ 2,916 $ 3,101 ============ ============ ============ ============ Earnings per share (3): Historical..................................................... $ 0.30 $ 0.25 $ 0.22 $ 0.19 Pro forma adjustments: Income on adjusted net proceeds................................ 0.19 0.20 0.19 0.20 Employee stock ownership plan (7).............................. (0.01) (0.01) (0.01) (0.01) Recognition and retention plan (2)............................. (0.03) (0.03) (0.03) (0.03) ------------ ------------ ------------ ------------ Pro forma earnings per share (3) (4)......................... $ 0.45 $ 0.41 $ 0.37 $ 0.35 ============ ============ ============ ============ Pro forma price to earnings....................................... 22.22x 24.39x 27.03x 28.57x Number of shares used in earnings per share calculations.......... 5,761,536 6,778,279 7,795,020 8,964,273 At December 31, 2001 - -------------------- Stockholders' equity: Historical..................................................... $ 41,630 $ 41,630 $ 41,630 $ 41,630 Estimated net proceeds......................................... 32,990 38,910 44,831 51,640 MHC capital consolidation...................................... 26 26 26 26 Common stock acquired by employee stock ownership plan (7) (680) (800) (920) (1,058) Common stock acquired by recognition and retention plan (2) (1,360) (1,600) (1,840) (2,116) ------------ ------------ ------------ ------------ Pro forma stockholders' equity (5)......................... 72,606 78,166 83,728 90,122 Intangible assets.............................................. (9,453) (9,453) (9,453) (9,453) ------------ ------------ ------------ ------------ Pro forma tangible stockholders' equity.................... $ 63,153 $ 68,713 $ 74,275 $ 80,669 ============ ============ ============ ============ Stockholders' equity per share (6): Historical..................................................... $ 7.15 $ 6.07 $ 5.28 $ 4.59 Estimated net proceeds......................................... 5.66 5.69 5.69 5.70 Common stock acquired by employee stock ownership plan (7)..... (0.12) (0.12) (0.12) (0.12) Common stock acquired by recognition and retention plan (2).... (0.23) (0.23) (0.23) (0.23) ------------ ------------ ------------ ------------ Pro forma stockholders' equity per share (5) (6)........... $ 12.46 $ 11.41 $ 10.62 $ 9.94 ============ ============ ============ ============ Pro forma tangible stockholders' equity per share.......... $ 10.84 $ 10.03 $ 9.42 $ 8.90 ============ ============ ============ ============ Offering price as percentage of pro forma stockholders' equity per share................................. 80.26% 87.64% 94.16% 100.60% Offering price as percentage of pro forma tangible stockholders' equity per share................................. 92.25% 99.70% 106.16% 112.36% Number of shares used in book value per share calculations........ 5,825,004 6,852,946 7,880,888 9,063,021
(footnotes on next page) 25 _________________________ (1) As adjusted to give effect to an increase in the number of shares which could occur due to a 15% increase in the offering range to reflect changes in market and financial conditions following the commencement of the offering. (2) If approved by Citizens South Banking Corporation's stockholders, the stock recognition and retention plan intends to purchase an aggregate number of shares of common stock equal to 4% of the shares to be sold in the offering. Stockholder approval of the stock recognition and retention plan and purchases by the plan may not occur earlier than six months after the completion of the conversion. The shares may be acquired directly from Citizens South Banking Corporation or through open market purchases. The funds to be used by the stock recognition and retention plan to purchase the shares will be provided by Citizens South Banking Corporation. The table assumes that (i) the stock recognition and retention plan acquires the shares through open market purchases at $10.00 per share, (ii) 20% of the amount contributed to the stock recognition and retention plan is amortized as an expense during the year ended December 31, 2001 and (iii) the stock recognition and retention plan expense reflects an effective combined federal and state tax rate of 36.0%. Assuming stockholder approval of the plan and that the plan shares are awarded through the use of authorized but unissued shares of common stock, stockholders would have their voting interests diluted by approximately 2.3%. (3) Per share figures include publicly held shares of Citizens South Banking Corporation common stock that will be exchanged for new shares of Citizens South Banking Corporation common stock in the conversion. See "The Conversion - Share Exchange Ratio." Net income per share computations are determined by taking the number of shares assumed to be sold in the offering and the number of new shares assumed to be issued in exchange for publicly held shares and, in accordance with Statement of Position 93-6, subtracting the recognition and retention plan shares and the employee stock ownership plan shares which have not been committed for release during the respective periods. See note 2 above. The number of shares of common stock actually sold and the corresponding number of exchange shares may be more or less than the assumed amounts. (4) No effect has been given to the issuance of additional shares of common stock pursuant to the stock option plan, which is expected to be adopted by Citizens South Banking Corporation following the offering and presented to stockholders for approval not earlier than six months after the completion of the conversion. If the stock option plan is approved by stockholders, a number of shares equal to 10% of the shares sold in the offering will be reserved for future issuance upon the exercise of options to be granted under the stock option plan. The issuance of authorized but previously unissued shares of common stock pursuant to the exercise of options under such plan would dilute existing stockholders' interests by approximately 5.5%. (5) The retained earnings of Citizens South Bank will be substantially restricted after the conversion. See "Our Dividend Policy," "The Conversion-Liquidation Rights" and "Supervision and Regulation-Federal Banking Regulation-Capital Distributions." (6) Per share figures include publicly held shares of Citizens South Banking Corporation common stock that will be exchanged for new shares of Citizens South Banking Corporation common stock in the conversion. Stockholders' equity per share calculations are based upon the sum of (i) the number of subscription shares assumed to be sold in the offering and (ii) new shares to be issued in exchange for publicly held shares at the minimum, midpoint, maximum and adjusted maximum of the offering range, respectively. The exchange shares reflect an exchange ratio of 1.3838, 1.6280, 1.8722 and 2.1530, respectively, at the minimum, midpoint, maximum and adjusted maximum of the offering range, respectively. The number of subscription shares actually sold and the corresponding number of exchange shares may be more or less than the assumed amounts. (7) Assumes that 2% of shares of common stock sold in the offering will be purchased by the employee stock ownership plan. For purposes of this table, the funds used to acquire these shares are assumed to have been borrowed by the employee stock ownership plan from the net proceeds of the offering retained by Citizens South Banking Corporation. Citizens South Bank intends to make annual contributions to the employee stock ownership plan in an amount at least equal to the principal of the debt. Citizens South Bank's total annual payments on the employee stock ownership plan debt are based upon 15 equal annual installments of principal and interest. Statement of Position 93-6 requires that an employer record compensation expense in an amount equal to the fair value of the shares committed to be released to employees. The pro forma adjustments assume that the employee stock ownership plan shares are allocated in equal annual installments based on the number of loan repayment installments assumed to be paid by Citizens South Bank, the fair value of the common stock remains that the subscription price and the employee stock ownership plan expense reflects an effective combined federal and state tax rate of 36.0%. The unallocated employee stock ownership plan shares are reflected as a reduction of stockholders' equity. No reinvestment is assumed on proceeds contributed to fund the employee stock ownership plan. The pro forma net income further assumes (i) that 4,533, 5,333, 6,133 and 7,053 shares were committed to be released during the twelve months ended December 31, 2001, at the minimum, mid-point, maximum, and adjusted maximum of the offering range, respectively, and (ii) in accordance with Statement of Position 93-6, only the employee stock ownership plan shares committed to be released during the period were considered outstanding for purposes of net income per share calculations. (8) Historical amounts of consolidated net earnings and earnings per share, and the pro forma net earnings and pro forma earnings per share, for the year ended December 31, 2001 do not reflect the operations of Innes Street Financial Corporation, which was acquired by Citizens South Banking Corporation effective December 31, 2001. The pro forma net earnings for the year ended December 31, 2001, giving effect to the acquisition of Innes Street Financial Corporation as if it had occurred effective January 1, 2001, as described in Note 2 to the consolidated financial statements of Citizens South Banking Corporation as of and for the year ended December 31, 2001 included elsewhere herein, is $2,801. Giving effect to the acquisition of Innes Street Financial Corporation as if it had occurred effective January 1, 2001, and giving effect to the pro forma adjustments related to the offering as described in this section, the pro forma net earnings for the year ended December 31, 2001 would be $3,692, $3,853, $4,013, and $4,198, respectively; the pro forma earnings per share would be $0.64, $0.57, $0.51, and $0.47, respectively; and the pro forma price to earnings ratio would be 15.63x, 17.54x, 19.61x, and 21.28x, respectively, at the minimum, midpoint, maximum, and adjusted maximum of the offering range. 26 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The discussion and analysis that follows focuses on the factors affecting our consolidated financial condition at March 31, 2002, December 31, 2001 and 2000 and consolidated results of operations for the three months ended March 31, 2002 and 2001 and for the years ended December 31, 2001 and 2000 and for the years ended September 30, 2000 and 1999. The consolidated financial statements and related notes appearing elsewhere in this prospectus should be read in conjunction with this review. The preparation of consolidated financial statements involves the application of accounting policies relevant to the business of our corporation and its subsidiaries. Application of certain accounting policies requires management to make estimates and assumptions about the effect of matters that are inherently uncertain. These estimates and assumptions affect the reported amounts of certain assets, liabilities, revenues and expenses. Different amounts could be reported under different conditions, or if different assumptions were used in the application of certain accounting policies. In this respect, the accounting policy considered by us to be critical relates to the determination of the allowance for loan losses. This accounting policy is discussed in the "--Allowance for Loan Losses" section of this prospectus and in note 1 of the notes to consolidated financial statements appearing elsewhere in this prospectus. Description of Business Citizens South Banking Corporation, formerly known as Gaston Federal Bancorp, Inc., was formed on March 18, 1998, for the purpose of acting as the holding company for Citizens South Bank, formerly known as Gaston Federal Bank. Citizens South Banking Corporation's assets consist primarily of the outstanding capital stock of Citizens South Bank, deposits held at Citizens South Bank, and investment securities. As of March 31, 2002, there were 1,752,427 shares of Citizens South Banking Corporation's common stock held by the public and 2,457,007 shares held by Citizens South Holdings, MHC, formerly known as Gaston Federal Holdings, MHC, the parent mutual holding company. The publicly held common stock currently trades on the Nasdaq National Market System under the symbol CSBC. Citizens South Banking Corporation's principal business is overseeing and directing the business of Citizens South Bank and investing the net stock offering proceeds retained by Citizens South Banking Corporation. Citizens South Bank, which was chartered in 1904, is a community bank engaged primarily in the business of offering FDIC-insured deposits to customers through its branch offices and investing those deposits, together with funds generated from operations and borrowings, in residential, commercial, construction and consumer loans, investment securities, and mortgage-backed securities. Our results of operations are dependent primarily on net interest income, which is the difference between the income earned on its loan and securities portfolios and its cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by our provision for loan losses, sales of assets, fee income generated from our deposit and loan accounts, and commissions on the sale of uninsured investment products. Our noninterest expense primarily consists of compensation and employee benefits, occupancy expense, professional services, advertising, and other noninterest expenses. Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates and actions of regulatory and governmental authorities. Comparison of Financial Condition at March 31, 2002 and December 31, 2001 Assets. Our total assets decreased by $4.3 million, or 1.0%, from $447.5 million as of December 31, 2001, to $443.3 million as of March 31, 2002. This decrease was due, in part, to the sale of $2.0 million in investment securities with the proceeds being used to prepay $1.5 million in Federal Home Loan Bank advances. During the period there were significant changes in our asset allocation. Cash and cash equivalents increased by $15.3 million to $36.2 million, while investment securities decreased by $3.1 million to $22.9 million and mortgage-backed securities decreased by $2.4 million to $23.0 million. The increase in cash and cash equivalents was primarily funded by increases in loan prepayments, the sale of investment securities, and prepayments of mortgage-backed securities. 27 Also, during the three-month period ended March 31, 2002, net loans decreased by $10.8 million, or 3.2%, to $323.5 million, as a greater portion of our loan originations was fixed-rate loans due to borrower preferences in the low interest rate environment, and such originated loans were sold in the secondary mortgage market. Most of this decrease was concentrated in the one- to four-family residential mortgage loan portfolio that decreased by $9.4 million, or 4.8% during the quarter. We generally sell all new fixed-rate residential loan production in order to reduce our overall vulnerability to rising interest rates. We will continue to focus on growing the loan portfolio in a safe and sound manner with an emphasis on the origination and retention of short-term, more interest-rate sensitive nonresidential loans and the origination and sale of mortgage loans. As of March 31, 2002, nonperforming assets amounted to 0.71% of total assets and loan loss reserves amounted to 0.91% of total loans. Liabilities. Total liabilities decreased by $4.9 million, or 1.2%, from $405.9 million as of December 31, 2001, to $401.0 million as of March 31, 2002. This decrease was due, in part, to the prepayment of a $1.5 million Federal Home Loan Bank advance using proceeds from the sale of investments. Also during the quarter, total deposits decreased by $1.6 million, or 0.5%, to $352.1 million as of March 31, 2002. However, we increased our local core deposit base of checking accounts, savings accounts and money market deposit accounts during the quarter. The decrease in deposits was concentrated in the higher-costing time deposit portfolio. We plan to continue our efforts to gain deposit market share through new product development and branch expansion with an emphasis on demand deposits. Borrowed money decreased by $1.0 million, or 2.5%, to $41.0 million. Borrowed money was primarily comprised of various callable and fixed-term Federal Home Loan Bank advances with a weighted average interest rate of 5.67%. Equity. Total equity increased by $607,000, or 1.5%, from $41.6 million as of December 31, 2001, to $42.2 million as of March 31, 2002. This increase was primarily due to the $992,000 in earnings during the period. The positive effects of earnings were offset, in part, by a $273,000 decrease in unrealized gains on available-for-sale securities and the payment of $140,000 in cash dividends. Comparison of Financial Condition at December 31, 2001 and 2000 General. On December 31, 2001, we completed our acquisition of all of the outstanding common stock of Innes Street Financial Corporation and its wholly owned subsidiary, Citizens Bank, in a cash transaction valued at $37.9 million. Citizens Bank was headquartered in Salisbury, North Carolina, and operated two other full-service branch offices in Statesville and Rockwell, North Carolina. At the time of the acquisition, we assumed the assets and liabilities of Innes Street at the estimated fair market value, including total assets of $221.8 million, net outstanding loans of $170.5 million, total deposits of $175.4 million, and total liabilities of $183.9 million. The acquisition was accounted for using the purchase method and resulted in intangible assets of $9.5 million, including a core deposit premium of $2.4 million, mortgage loan servicing rights of $425,000, and goodwill of $6.6 million. In addition, there were mark-to-market increases of $1.0 million for loans, $1.8 million for fixed assets, $60,000 for investments, $1.4 million for deposits, and $1.5 million for deferred tax liabilities. Assets. Total assets for the fiscal year ended December 31, 2001, increased by $194.8 million, or 77.1%, from $252.7 million to $447.5 million. The change in assets was primarily due to the acquisition of Innes Street, which had total assets of $221.8 million, less the acquisition price of $37.9 million. Cash and cash equivalents decreased by $5.8 million, or 21.6%, and investment securities decreased by $6.9 million, or 20.9%. These funds were primarily used to fund a portion of the proceeds needed for the cash acquisition. Net outstanding loans increased by $175.5 million, or 110.5%, from $158.8 million to $334.3 million. This change represented a $5.0 million increase in net outstanding loans from our normal operations, and $170.5 million in net outstanding loans of Innes Street. Real estate owned increased to $1.5 million. This was primarily comprised of one commercial building acquired by Citizens Bank through foreclosure. The property, which is currently listed for sale, had a net book balance of $1.3 million. Premises and equipment increased by $4.5 million, or 107.6%. This increase was primarily due to the opening of a new branch office in 2001, and the $3.8 million premises and equipment on the books of Innes Street. Increases in Federal Home Loan Bank stock of $1.7 million, core deposit premium of $2.4 million, and goodwill of $6.6 million, were solely due to the acquisition. The $12.5 million increase in other assets was due, in part, to $5.1 million in investments related to deferred compensation plans of Citizens Bank and the $2.6 million purchase of additional bank-owned life insurance. 28 Liabilities. Total liabilities for the fiscal year ended December 31, 2001, increased by $193.0 million, or 90.6%, from $213.0 million to $406.0 million. This change was primarily due to the acquisition of Innes Street, which had total liabilities of $183.9 million. Total deposits increased by $185.8 million as a result of an increase of $10.4 million in deposits from our normal operations and $175.4 million in total deposits from Innes Street. Funds generated from deposits were used to fund loans and provide a portion of the proceeds needed for the cash acquisition. We plan to continue to aggressively market our retail deposit products to the local community and to increase our deposit market share through an expanding branch network. Borrowed money decreased slightly by $680,000, or 1.6%, from $42.7 million to $42.1 million. Deferred compensation and other liabilities increased by $4.8 million and $4.2 million, respectively. These increases were primarily the result of the acquisition, which included $5.1 million in deferred compensation plans payable from Innes Street and a $1.5 million increase in deferred tax liabilities resulting from the purchase price allocation in conjunction with the acquisition. Equity. Total equity for the fiscal year ended December 31, 2001, increased by $1.9 million, or 4.7%, from $39.8 million to $41.6 million. This increase was due to $1.7 million in net income for the year, a $525,000 increase in the accumulated unrealized gains on available for sale securities, and a $283,000 allocation of common stock purchased with the loan to our employee stock ownership plan. These increases were offset by cash dividend payments of $529,000 and the repurchase of 9,500 shares of common stock for $115,000. Comparison of Results of Operations for the Three Months Ended March 31, 2002 and 2001 General. Net income for the three months ended March 31, 2002, amounted to $992,000, or $0.24 per share, as compared to $512,000, or $0.13 per share, for the three months ended March 31, 2001. Net income for the quarter ended March 31, 2002, included $387,000 in amortization of intangible assets, resulting in net cash earnings of $1.2 million, or $0.30 per basic share outstanding. Net interest income. Net interest income increased by $2.0 million, or 117.6%, to $3.6 million for the three months ended March 31, 2002. This increase was primarily due to the acquisition of Innes Street. Interest income increased by $2.0 million, or 45.3%. This increase was the result of a $158.6 million, or 65.5%, increase in average interest-earning assets, coupled with an 87 basis point decrease in the average interest rate to 6.38%. Interest expense remained flat during the period. Average interest-bearing liabilities increased by $177.1 million, or 84.9%, the effects of which were offset by a 244 basis point reduction in the cost of funds to 2.8%. Our net interest margin was 3.25% for the quarter ended March 31, 2002, compared to 2.69% for the quarter ended March 31, 2001. Provision for loan losses. The provision for loan losses amounted to $65,000 for the three months ended March 31, 2002, compared to $30,000 for the three months ended March 31, 2001. The amount of the provision for loan losses was increased, in part, due to the increased loan volume resulting from the acquisition of Innes Street and a continued emphasis on commercial and consumer loans. The ratio of loan loss reserves to gross loans was 0.91% as of March 31, 2002, and 0.96% as of March 31, 2001. Noninterest income. Noninterest income, net of nonrecurring gains on sales of assets, amounted to $930,000 for the three months ended March 31, 2002, as compared to $618,000 for the three months ended March 31, 2001. This increase of $312,000, or 50.5%, was primarily due to increased fees generated by our mortgage-banking department, additional fee income derived from deposit products, and the increase in deposit accounts resulting from the acquisition of three full-service branch offices. Management plans to continue in its efforts to increase its outstanding balance of fee-generating demand deposit accounts through targeted advertising and branch expansion. Total demand deposit accounts increased by $10.2 million, or 41.0%, during the past 12 months to $35.2 million as of March 31, 2002. During the quarter ended March 31, 2002, we recognized a nonrecurring gain of $98,000 from the sale of $2.0 million in investment securities and $1.3 million in fixed rate mortgage loans. Noninterest expense. Noninterest expense amounted to $3.0 million for the three months ended March 31, 2002, compared to $1.5 million for the quarter ended March 31, 2001, an increase of $1.5 million. This increase was primarily due to higher compensation and occupancy expenses associated with our acquisition of three full-service branch offices, increased expenses associated with servicing our growing demand deposit account portfolio, costs associated with the changing of the bank's name from Gaston Federal Bank to Citizens South Bank, and expenses associated with converting Innes Street's computer system and back-office operations. During the quarter ended March 31, 2002, we successfully consolidated the back-office operations of the accounting department, payroll 29 processing, loan administration, marketing and human relations. In addition, the core processing systems were converted to our existing core processing system. These operations were consolidated with limited disruption of normal operations and should improve our overall efficiency. Income taxes. Income taxes amounted to $550,000, or 35.7% of taxable income, for the quarter ended March 31, 2002, as compared to $230,000, or 31.0% of taxable income, for the quarter ended March 31, 2001. The increase in the overall tax rate was due to a lower percentage of income being derived from tax-advantaged assets such as municipal securities, bank-owned life insurance, and government agency securities. Comparison of Results of Operations for the Years Ended December 31, 2001 and 2000 General. The acquisition of Innes Street was completed on December 31, 2001. Accordingly, the results of operations of Innes Street have not been included in our consolidated statement of operations for the year ended December 31, 2001. Net earnings were $1,704,000, or $0.42 per share, for the fiscal year ended December 31, 2001, compared to $1,748,000, or $0.43 per share, for the fiscal year ended December 31, 2000. Net interest income decreased by $537,000, or 7.5%, due to significant decreases in short-term interest rates during 2001, coupled with abnormally high levels of low-yielding liquid assets. This decrease was offset by a $804,000, or 36.5%, increase in recurring noninterest income, resulting from increased fees generated from deposit accounts and loans. Recurring noninterest expense increased by $592,000, or 9.7%, due to expenses associated with the opening of a new branch office in 2001 and increased expenses associated with servicing deposit accounts. The provision for loan losses increased from $53,000 in fiscal 2000 to $120,000 in fiscal 2001. Net losses on sales of assets decreased from $602,000 in fiscal 2000 to $10,000 in fiscal 2001. Interest Income. Interest income for the fiscal year ended December 31, 2001, decreased by $451,000, or 2.7%, to $16.4 million. This decrease was primarily due to significant decreases in short-term interest rates during 2001, coupled with abnormally high levels of low-yielding liquid assets held by Citizens South Bank in anticipation of the $37.9 million cash acquisition of Innes Street. These liquid assets would normally have been used to purchase higher-yielding investment or mortgage-backed securities. Interest earned on loans decreased by $1.1 million, or 8.0%, to $12.3 million due to the prepayment of higher-yielding mortgage loans and the decreased yield on adjustable loans resulting from a 4.25% decrease in the prime lending rate during the year. During the year, average outstanding loans decreased by $8.0 million, or 4.6%, from $174.6 million to $166.6 million, while the yield on loans decreased from 7.6% to 7.4%. Interest earned on investment securities decreased by $186,000, or 9.9%, while interest earned on mortgage-backed securities decreased $21,000, or 1.5%. The average balance of investment securities decreased by $2.3 million to $29.1 million, and the yield decreased from 6.0% to 5.8% due to lower market rates. Average outstanding mortgage-backed securities increased by $3.6 million to $25.2 million, while the yield decreased from 6.7% to 5.7% due to lower market rates. Interest earned on interest-bearing deposits increased by $825,000, or 491.4%. Average interest-earning bank deposits increased by $21.8 million from $2.9 million to $24.7 million, the effects of which were offset by a decrease in the average yield from 5.7% to 4.0%. The increase in average balances was due to liquid assets held in anticipation of the acquisition, while the decrease in average yield was due to a significant decline in short-term interest rates during the 2001 fiscal year. Interest Expense. Interest expense for the fiscal year ended December 31, 2001, increased $86,000, or 0.9%, to $9.8 million. This increase was due to a $77,000, or 1.1%, increase in interest paid on deposits and a $9,000, or 0.4%, increase in interest paid on borrowings. Average interest-bearing deposits increased $14.0 million, or 9.0%, to $168.8 million. The average interest rate paid on deposits decreased from 4.7% to 4.2% from fiscal 2000 to fiscal 2001 due to lower market rates. In 2001, we increased our market share in Gaston County from fourth place to second place in a field of 13 banks. Average borrowings increased by $1.9 million, or 4.6%, to $42.8 million, while the rate paid on borrowings decreased from 5.8% to 5.6% due to lower market interest rates. Net Interest Income. Net interest income decreased by $537,000, or 7.5%, from $7.1 million for fiscal 2000 to $6.6 million for fiscal 2001. Net interest margin decreased from 2.9% for fiscal 2000 to 2.5% for fiscal 2001. Average interest-earning assets increased $15.0 million to $245.7 million, while average interest-bearing liabilities increased $15.9 million to $211.6 million. Our percentage of interest-earning assets to interest-bearing liabilities decreased from 117.9% to 116.1%. The primary reasons for this change were the purchase of $2.6 million in bank-owned life insurance and the addition of a full service branch office. 30 Provision for Loan Losses. We provided $120,000 and $53,000 in loan loss provisions for the fiscal years ended December 31, 2001 and 2000, respectively. Our allowance for loan losses was $3.1 million, or 0.91% of total loans, at December 31, 2001, compared to $1.6 million, or 0.95% of total loans, at December 31, 2000. The ratio of nonperforming loans to total loans amounted to 0.34% and 0.28% for the fiscal years ended 2001 and 2000, respectively. We will make future loan loss provisions based on available information, including changes in economic conditions, changes in the loan portfolio mix and performance, and regulatory requirements. Noninterest Income. Recurring noninterest income is composed of fees on deposit and loan accounts, commissions on the sale of investment products, Federal Home Loan Bank dividends, and other operating income. For the fiscal year ended December 31, 2001, recurring noninterest income increased by $804,000, or 36.5%, from $2.2 million to $3.0 million. The primary reasons for the change were a $1.0 million increase in fees on deposit accounts and a $119,000 increase in loan fee income. The increase in fees on deposit accounts resulted from an aggressive marketing program to increase fee generating demand deposit accounts, the opening of a new branch office, and a competitive fee structure on deposit products. Loan fee income increased due to a higher number of loan originations resulting, in part, from lower interest rates. Other income increased by $202,000 due, in part, to income generated from additional purchases of bank-owned life insurance. These increases were offset by a $550,000 reduction in commissions earned on the sale of investment products resulting from a slowdown in the economy. Noninterest income also includes gains on the sale of assets, which is considered to be a nonrecurring source of noninterest income. During the fiscal year ended December 31, 2001, we did not recognize any gains on the sale of assets. During the fiscal year ended December 31, 2000, we sold $5.3 million in investment securities, $595,000 in mortgage-backed securities, and mortgage loan servicing of a $17.2 million portfolio of residential loans at a gain of $271,000. Noninterest Expense. Recurring noninterest expense is composed of compensation and benefits, office occupancy, deposit insurance, data processing, advertising, professional services, and other expenses incurred during the normal course of business. Recurring noninterest expense increased by $592,000, or 9.7%, from $6.1 million in 2000 to $6.7 million in 2001. The primary reasons for the change were a $125,000, or 3.4%, increase in compensation and benefits, a $121,000, or 19.8%, increase in office occupancy, and a $576,000, or 52.8%, increase in other recurring noninterest expenses. The increases were the result of us adding a full-service branch office in February 2001 and additional expenses associated with the servicing of a larger number of fee-generating transaction deposit accounts. We also recognized expenses of $259,000 associated with the integration of the data processing and other operations associated with the Innes Street acquisition and $129,000 related to the release of additional employee stock ownership plan shares. We recognized modest decreases in professional services, deposit insurance, and advertising. Noninterest expense also includes losses on the sale of assets, which is considered to be a nonrecurring expense. During the fiscal year ended December 31, 2001, we sold $1.3 million in mortgage-backed securities at a loss of $10,000. During the fiscal year ended December 31, 2000, we sold $18.2 million in loans at a loss of $873,000. These loans were primarily long-term fixed-rate mortgage loans that were sold in order to reduce our exposure to rising interest rates. The proceeds were used to fund the origination of shorter-term nonresidential loans and adjustable-rate home equity lines of credit. Provision for Income Taxes. Our provision for income taxes was $702,000 and $846,000 for the fiscal years ended December 31, 2001, and 2000, respectively. The change was primarily due to a $188,000 reduction in pretax income and an increase in tax-advantaged assets such as municipal securities, U.S. Government Agency securities, and bank-owned life insurance that generate tax-exempt income. The purchase of these tax-advantaged assets resulted in a decrease in the effective tax rate from 32.6% to 29.2%. Comparison of Results of Operations for the Years Ended September 30, 2000 and 1999 General. Net income for the twelve months ended September 30, 2000, increased by $24,000, or 1.1%, to $2.2 million. This change was primarily due to a $155,000 decrease in net interest income, a $75,000 reduction in the provision for loan losses, a $1.1 million decrease in the gain on sale of assets, an $826,000 increase in operating 31 noninterest income, a $298,000 decrease in noninterest expense, and a $111,000 reduction in the income tax provision. Interest Income. Interest income for the twelve months ended September 30, 2000, increased by $1.2 million, or 7.7%, to $16.4 million. This change was primarily due to a $987,000 increase in interest earned on loans. This additional interest income was due to a $15.6 million, or 9.9%, increase in average outstanding loans to $174.2 million. The yield on loans remained flat at 7.5% primarily due to deferred fees recognized as a result of the sale of $13.1 million in mortgage loans in fiscal 1999. Interest earned on investment securities increased by $67,000, or 3.3%, while interest earned on mortgage-backed securities increased by $122,000, or 10.3%. The average balance of investment securities decreased by $641,000, the effects of which were offset by an increase in yield from 5.8% to 6.1% due to higher market rates. Average outstanding mortgage-backed securities decreased by $204,000, while the yield increased from 5.7% to 6.3% due to higher market rates. Interest Expense. Interest expense for the twelve months ended September 30, 2000, increased $1.3 million, or 16.9%, to $9.2 million. This increase was due to a $561,000, or 8.8%, increase in interest paid on deposits and a $769,000, or 52.0%, increase in interest paid on borrowings. Average deposits increased $8.8 million, or 5.8%, to $160.0 million. The average interest rate paid on deposits increased from 4.2% to 4.4% from 1999 to 2000. Average borrowings increased by $11.0 million, or 38.3%, to $39.6 million. The rate paid on borrowings increased from 5.2% to 5.7% due to higher interest rates on additional advances taken in 2000. Net Interest Income. Net interest income decreased by $155,000, or 2.1%, from $7.4 million for 1999 to $7.2 million for 2000. Net interest margin decreased slightly from 3.3% for 1999 to 3.0% for 2000. Average interest-earning assets increased $12.9 million while average interest-bearing liabilities increased $19.8 million. The primary reasons for this change were the purchase of $2.0 million in bank-owned life insurance, the $1.8 million repurchase of common stock, and the addition of a full service branch office. Provision for Loan Losses. We provided $30,000 and $105,000 in loan loss provisions for the years ended September 30, 2000 and 1999, respectively. Our allowance for loan losses was $1.5 million, or 0.84% of total loans, for the year ended September 30, 2000, compared to $1.5 million, or 0.86% of total loans, for the year ended September 30, 1999. The ratio of nonperforming loans to total loans amounted to 0.15% and 0.06% for the years ended September 30, 2000 and 1999, respectively. We will make future loan loss provisions based on available information, including changes in economic conditions, changes in loan portfolio mix and performance, and regulatory requirements. Noninterest Income. For the year ended September 30, 2000, operating noninterest income increased by $826,000, or 83.9%, from $985,000 to $1.8 million. The primary reasons for the increase were a $221,000 increase in service charges on deposit accounts, a $303,000 increase in commissions on the sale of investment products, a $44,000 increase in Federal Home Loan Bank dividends, and a $259,000 increase in other income. The increase in service charges on deposit accounts resulted from an aggressive marketing program to increase fee generating demand deposit accounts and a competitive fee structure on deposit products. Other income increased due to fees generated as a result of strong loan demand and increased commissions generated on the sale of uninsured investment products by Citizens South Bank's wholly owned subsidiary. Noninterest income also included gains on the sale of assets, which is considered to be a nonrecurring source of noninterest income. During the year ended September 30, 2000, we sold $2.2 million in investment securities and $595,000 in mortgage-backed securities at a gain of $225,000, and $17.2 million in loan servicing and $10,000 in loans at a gain of $32,000. During the year ended September 30, 1999, we sold $5.9 million in investment securities and $492,000 in mortgage-backed securities at a gain of $1.3 million, and $13.1 million in loans and $49,000 in premises and equipment at a gain of $117,000. This resulted in a decrease in the gain on the sale of assets of $1.1 million from 1999 to 2000. Noninterest Expense. For the year ended September 30, 2000, noninterest expense decreased $298,000, or 4.8%, from $6.3 million to $6.0 million. The primary reason for the decrease was a $369,000 decrease in salary and benefits and modest decreases in professional services, deposit insurance and advertising. A $166,000 increase in occupancy expense and modest increases in data processing and other noninterest expenses offset these benefits. The decrease in salary and benefits was primarily due to a $1.0 million non-recurring expense incurred during the 32 year ended September 30, 1999, associated with the award of common stock in accordance with the 1999 Recognition and Retention Plan approved by our shareholders in April 1999. Occupancy expense increased as a result of the opening of a new full service branch in Dallas, North Carolina, in February 2000 and a loan production office in Shelby, North Carolina, in October 1999. Provision for Income Taxes. Our provision for income taxes was $1.1 million and $1.2 million for the years ended September 30, 2000 and 1999, respectively. The change was primarily due to an increase in tax-advantaged assets such as municipal securities, U.S. Government Agency securities and bank-owned life insurance that generate tax-exempt income. The purchase of these tax-advantaged assets resulted in a decrease in the effective tax rate from 35.7% to 33.2%. Net Interest Income Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income also depends on the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rate earned or paid on them, respectively. The following table sets forth certain information relating to Citizens South Banking Corporation at March 31, 2002, for the three months ended March 31, 2002 and 2001, and for the twelve months ended December 31, 2001 and 2000 and for the twelve months ended September 30, 2000 and 1999. For the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, is expressed both in dollars and rates. No tax equivalent adjustments were made.
Three Months Ended March 31, ---------------------------------------------------------------- At March 31, 2002 2002 2001 -------------------- ------------------------------ ------------------------------- Average Interest Average Interest Outstanding Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Balance Rate Balance Paid Rate Balance Paid Rate ----------- ------ ----------- -------- ------ ----------- -------- ------- (Dollars In Thousands) Interest-earning assets: Investment securities (1) ............ $ 22,859 6.22% $ 23,054 $ 321 5.57% $ 31,205 $ 468 6.00% Mortgage-backed securities ........... 23,007 5.23 24,711 288 4.66 23,471 368 6.27 Interest-bearing bank deposits ....... 32,798 1.66 24,448 102 1.67 23,751 346 5.83 Loans receivable (2) ................. 323,528 6.85 330,236 5,588 6.77 164,368 3,153 7.67 ----------- ------- ----------- ------- ------- ----------- ------- ------ Total interest-earning assets .......... 402,192 6.30 402,449 6,299 6.26 242,795 4,335 7.14 ------- ------- ------- ------- ------ Noninterest-earning assets ............. 41,093 41,585 16,733 ----------- ----------- ----------- Total assets ........................... $ 443,285 $ 444,034 $ 259,528 =========== =========== =========== Interest-bearing liabilities: Demand deposit accounts .............. $ 25,497 0.46 $ 24,928 $ 23 0.37 $ 14,242 $ 59 1.66 Money market deposit accounts ........ 30,946 1.53 32,820 122 1.49 17,235 140 3.25 Savings accounts ..................... 46,385 1.54 45,383 169 1.49 17,793 122 2.74 Certificates of deposit .............. 239,574 2.80 243,361 1,811 2.98 117,388 1,726 5.88 Borrowed funds ....................... 41,009 5.38 41,608 551 5.30 44,025 623 5.66 ----------- ------- ----------- ------- ------- ----------- ------- ------ Total interest-bearing liabilitiess..... 383,411 2.67 388,100 2,676 2.76 201,683 2,670 5.07 ------- ------- ------- ------ Noninterest-bearing liabilities ........ 17,637 13,912 8,718 ----------- ----------- ----------- Total liabilities ...................... 401,048 402,012 219,401 Total equity ........................... 42,237 42,022 40,127 ----------- ----------- ----------- Total liabilities and retained earnings ............................. $ 443,285 $ 444,034 $ 259,528 =========== =========== =========== Net interest income .................... $ 3,623 $ 1,665 ======= ======= Interest rate spread (3) ............... 3.63% 3.50% 2.07% ======== ======= ====== Net yield on interest-earning assets (4) ............................. 3.60% 2.74% ======= ====== Ratio of average interest- earning assets to interest- bearing liabilities ................... 103.70% 115.24% ======= ======
33
For the Twelve Months Ended ----------------------------------------- December 31, 2001 ----------------------------------------- Average Interest Outstanding Earned/ Yield/ Balance Paid Rate --------------- ------------ ------------ Interest-earning assets: Investment securities (1) .......................... $ 53,857 $ 2,697 5.01% Mortgage-backed securities ......................... 25,221 1,434 5.69 Loans receivable (2) ............................... 166,574 12,252 7.36 ---------- -------- ------ Total interest-earning assets ........................ $ 245,652 $ 16,383 6.67% Noninterest-earning assets ........................... 17,148 ---------- Total assets ......................................... $ 262,800 ========== Interest-bearing liabilities: Demand deposit accounts ............................ $ 15,285 $ 186 1.22% Money market deposit accounts ...................... 16,862 460 2.73 Savings accounts ................................... 18,677 398 2.13 Certificates of deposit ............................ 117,993 6,329 5.36 Borrowed funds ..................................... 42,803 2,398 5.60 ---------- -------- ------ Total interest-bearing liabilities ................... $ 211,620 $ 9,771 4.62% -------- Noninterest-bearing liabilities ...................... 10,304 ---------- Total liabilities .................................... 221,924 Total equity ......................................... 40,876 ---------- Total liabilities and retained earnings .............. $ 262,800 ========== Net interest income .................................. $ 6,612 ======== Interest rate spread (3) ............................. 2.05% ====== Net yield on interest-earning assets (4) ............. 2.69% ====== Ratio of average interest-earning assets to interest-bearing liabilities .................... 116.08% ====== For the Twelve Months Ended ----------------------------------------------------------------------- December 31, 2000 September 30, 2000 ----------------------------------- ----------------------------------- Average Interest Average Interest Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Balance Paid Rate Balance Paid Rate -------------- --------- ---------- ------------- --------- ----------- (Dollars In Thousands) Interest-earning assets: Investment securities (1) ..................... $ 34,409 $ 2,058 5.98% $ 34,817 $ 2,127 6.11% Mortgage-backed securities .................... 21,641 1,455 6.72 20,546 1,302 6.34 Loans receivable (2) .......................... 174,610 13,320 7.63 174,176 12,985 7.46 ---------- ------- ------ --------- ------- ------ Total interest-earning assets ................... $ 230,660 $16,833 7.29% $ 229,539 $16,414 7.15% Noninterest-earning assets ...................... 14,083 13,408 ---------- --------- Total assets .................................... $ 244,743 $ 242,947 ========== ========= Interest-bearing liabilities: Demand deposit accounts ....................... $ 13,685 $ 230 1.68% 19,571 226 1.15% Money market deposit account .................. 14,096 489 3.47 13,841 452 3.27 Savings accounts .............................. 21,270 636 2.99 22,636 693 3.06 Certificates of deposit ....................... 105,734 5,941 5.62 103,964 5,597 5.38 Borrowed funds ................................ 40,931 2,388 5.83 39,639 2,251 5.68 ---------- ------- ------ --------- ------- ------ Total interest-bearing liabilities .............. $ 195,716 $ 9,684 4.95% $ 199,651 $ 9,219 4.62% ------- ------- Noninterest-bearing liabilities ................. 9,813 3,798 ---------- --------- Total liabilities ............................... 205,529 203,449 Total equity .................................... 39,214 39,498 ---------- --------- Total liabilities and retained earnings ......... $ 244,743 $ 242,947 ========== ========= Net interest income ............................. $ 7,149 $ 7,195 ======= ======= Interest rate spread (3) ........................ 2.34% 2.53% ====== ====== Net yield on interest-earning assets (4) ........ 3.10% 3.13% ====== ====== Ratio of average interest-earning assets to interest-bearing liabilities ............... 117.85% 114.97% ====== ====== For the Twelve Months Ended ---------------------------------------- September 30, 1999 ---------------------------------------- Average Interest Outstanding Earned/ Yield/ Balance Paid Rate --------------- ----------- ------------ Interest-earning assets: Investment securities (1) ..................... $ 35,458 $ 2,059 5.81% Mortgage-backed securities .................... 20,750 1,181 5.69 Loans receivable (2) .......................... 160,443 11,999 7.48 --------- ------- ------ Total interest-earning assets ................... $ 216,651 $15,239 7.04% Noninterest-earning assets ...................... 8,269 --------- Total assets .................................... $ 224,920 ========= Interest-bearing liabilities: Demand deposit accounts ....................... 17,413 194 1.11% Money market deposit accounts ................. 13,152 397 3.02 Savings accounts .............................. 22,624 717 3.17 Certificates of deposit ....................... 98,030 5,099 5.20 Borrowed funds ................................ 28,658 1,481 5.17 --------- ------- ------ Total interest-bearing liabilities .............. $ 179,877 $ 7,888 4.39% ------- Noninterest-bearing liabilities ................. 3,420 --------- Total liabilities ............................... 183,297 Total equity .................................... 41,623 --------- Total liabilities and retained earnings ......... $ 224,920 ========= Net interest income ............................. $ 7,351 ======= Interest rate spread (3) ........................ 2.65% ====== Net yield on interest-earning assets (4) ........ 3.39% ====== Ratio of average interest-earning assets to interest-bearing liabilities ............... 120.44% ======
_______________________________ (1) Investment securities includes interest-earning bank balances. (2) Average balances include nonaccrual loans. (3) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (4) Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets. 34 The table below sets forth information regarding changes in our interest income and interest expense for the periods indicated. For each category of our interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (changes in volume multiplied by old rate); (ii) changes in rate (changes in rate multiplied by old volume); (iii) changes in rate-volume (changes in rate multiplied by the change in volume).
For the Three Months Ended For the Twelve Months Ended March 31, 2002 December 31, 2001 vs. March 31, 2001 vs. December 31, 2000 Increase (Decrease) Due to Increase (Decrease) Due to ----------------------------------- ----------------------------------- Rate/ Rate/ Volume Rate Volume Total Volume Rate Volume Total ------- -------- ------- ------- -------- ------- ------- ------- (In Thousands) Interest income: Securities and other interest-earning assets ........................ (112) (281) 2 (391) $ 1,111 $ (100) $ (372) $ 639 Mortgage-backed and related securities .................... 19 (94) (5) (80) 239 (225) (35) (21) Loan portfolio ................. 3,182 (372) (375) 2,435 (613) (477) 22 (1,068) ------- ------- ------- ------- ------- ------ ------ ------ Total interest income ...................... 3,089 (747) (378) 1,964 737 (802) (385) (450) ------- ------- ------- ------- ------- ------ ------ ------ Interest expense: Deposits ....................... 2,212 (1,030) (1,104) 78 734 (620) (37) 77 Borrowed funds ................. (34) (40) 2 (72) 110 (96) (4) 10 ------- ------- ------- ------- ------- ------ ------ ------ Total interest expense ..................... 2,178 (1,070) (1,102) 6 844 (716) (41) 87 ------- ------- ------- ------- ------- ------ ------ ------ Net interest income ...................... $ 911 $ 323 $ 724 $ 1,958 $ (107) $ (86) $ (344) $ (537) ======= ======= ======= ======= ======= ====== ====== ====== For the Twelve Months Ended September 30, 2000 vs. September 30, 1999 Increase (Decrease) Due to ------------------------------------ Rate/ Volume Rate Volume Total ------- ------- ------- ------- Interest income: Securities and other interest-earning assets ........................ $1,027 $ (38) $ (3) $ 986 Mortgage-backed and related securities .................... (37) 107 (2) 68 Loan portfolio ................. (12) 134 (1) 121 ------ ------ ------ ------ Total interest income ...................... 978 203 (6) 1,175 ------ ------ ------ ------ Interest expense: Deposits ....................... 354 195 13 562 Borrowed funds ................. 567 146 56 769 ------ ------ ------ ------ Total interest expense ..................... 921 341 69 1,331 ------ ------ ------ ------ Net interest income ...................... $ 57 $ (138) $ (75) $ (156) ====== ======= ====== ======
Management of Market Risk Our most significant form of market risk is interest rate risk, as the majority of our assets and liabilities are sensitive to changes in interest rates. Our Asset/Liability Committee is responsible for monitoring and managing exposure to interest rate risk and ensuring that the level of sensitivity of our net portfolio value is maintained within limits established by the Board of Directors. Through such management, the Committee seeks to reduce the vulnerability of our operations to changes in interest rates. During the past year, the Committee utilized the following strategies to manage interest rate risk: (1) emphasizing the origination and retention of short-term commercial business loans and nonresidential mortgage loans, (2) emphasizing the origination of adjustable-rate home equity lines of credit; (3) emphasizing the origination and retention of one- to four- family residential adjustable-rate mortgage loans; (4) selling all new fixed-rate mortgage loans; (5) emphasizing transaction accounts and core deposit accounts; and (6) investing in shorter-term investment securities. The Office of Thrift Supervision, Citizens South Bank's primary regulator, requires the computation of amounts by which the net present value of the our cash flow from assets, liabilities, and off balance sheet items (our net portfolio value or "NPV") would change in the event of a range of assumed changes in market interest rates. These computations estimate the effect on a bank's NPV from instantaneous and permanent one hundred to three hundred basis point increases and decreases in market interest rates. The following table presents our projected change in NPV at March 31, 2002, as calculated by an independent third party, based upon information provided by us. 35 Changes in Interest Rates Projected NPV Change Board Limit 300 basis point rise -23.6% -45.0% 200 basis point rise -15.6% -30.0% 100 basis point rise -7.0% -15.0% No change 0.0% 0.0% 100 basis point decline 4.5% -15.0% 200 basis point decline 1.2% -30.0% 300 basis point decline -0.7% -45.0% Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. Modeling changes in NPV require the making of certain assumptions, which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the NPV table presented assumes that the composition of our interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the NPV table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results. Impact of Inflation and Changing Prices The consolidated financial statements and related notes have been prepared in accordance with U.S. generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars, without considering the change in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, nearly all of our assets and liabilities are financial in nature. As a result, interest rates have a more significant impact on our performance than the effect of inflation. Interest rates do not necessarily change in the same magnitude as the price of goods and services. Liquidity and Capital Resources Our liquidity management objective is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on opportunities for expansion. Liquidity management addresses the ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature, and to fund new loans and investments as opportunities arise. Our primary sources of internally generated funds are principal and interest payments on loans receivable, cash flows generated from operations, and cash flows generated by investments. External sources of funds include increases in deposits and FHLB advances. At March 31, 2002, we had loan commitments (excluding undisbursed portions of construction loans of $5.6 million) of $4.9 million and unused lines of credit of $59.7 million. We believe that we have adequate resources to fund loan commitments as they arise. If we require funds beyond our internal funding capabilities, we have $71.0 million in additional advances available from our line of credit from the Federal Home Loan Bank. At March 31, 2002, approximately $213.8 million of time deposits were scheduled to mature within a year, and we expect that a portion of these time deposits will not be renewed upon maturity. From time to time, we utilize advances from the FHLB primarily in connection with our management of the interest rate sensitivity of our assets and liabilities. In 2001, we repaid advances of $5.7 million and obtained new advances of $5.0 million while in 2000, we repaid advances of $3.0 million and obtained new advances of $10.0 million. Total advances outstanding at March 31, 2002 amounted to $39.0 million and we had the capacity to increase that amount to $110.0 million. Our most liquid assets are cash and due from banks, short-term investments and debt securities. At March 31, 2002, such assets amounted to $36.4 million, or 8.2% of total assets. 36 At March 31, 2002, Citizens South Bank exceeded all regulatory capital requirements. Citizens South Bank's Tier 1 capital was $28.2 million, or 6.5% of adjusted assets. The minimum required Tier 1 capital ratio is 4.00%. Impact of Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141 "Business Combinations," which requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method. The pooling-of-interests method of accounting is prohibited except for combinations initiated before June 30, 2001. The remaining provisions of SFAS No. 141 relating to business combinations accounted for by the purchase method, including identification of intangible assets, accounting for negative goodwill, financial statement presentation and disclosure, are effective for combinations completed after June 30, 2001. Management will follow the provisions of SFAS No. 141 for any acquisitions initiated after June 30, 2001. In June 2001, the FASB issued SFAS No. 142 "Goodwill and Intangible Assets," which prescribed accounting for all purchased goodwill and intangible assets. Pursuant to SFAS No. 142, acquired goodwill is not amortized, but is tested for impairment at the reporting unit level annually and whenever an impairment indicator arises. All goodwill should be assigned to reporting units that are expected to benefit from the goodwill. When an entity reorganizes its reporting structure, goodwill should be reallocated to reporting units based on the relative fair values of the units. Goodwill impairment should be tested with a two-step approach. First, the fair value of the reporting unit should be compared to its carrying value, including goodwill. If the reporting unit's carrying value exceeds its fair value, then any goodwill impairment should be measured as the excess of goodwill's carrying value over its implied fair value. The implied fair value of goodwill should be calculated in the same manner as goodwill is calculated for a business combination, using the reporting unit's fair value as the "purchase price" over the amounts allocated to assets, including unrecognized intangible assets, and liabilities of the reporting unit. Goodwill impairment losses should be reported in the income statement as a separate line item within operations, except for such losses included in the calculation of a gain or loss from discontinued operations. An acquired intangible asset, other than goodwill, should be amortized over its useful economic life. The useful life of an intangible asset is indefinite if it extends beyond the foreseeable horizon. If an asset's life is indefinite, the asset should not be amortized until the life is determined to be finite. Intangible assets being amortized should be tested for impairment in accordance with SFAS No. 121. Intangible assets not being amortized should be tested for impairment annually and whenever there are indicators of impairment, by comparing the asset's fair value to its carrying amount. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. SFAS No. 142 will have no current effect on our financial position or results of operations. At March 31, 2002, Citizens South Bank exceeded all regulatory capital requirements. Citizens South Bank's Tier 1 capital was $28.2 million, or 6.5% of adjusted assets. The minimum required Tier 1 capital ratio is 4.00%. Impact of Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141 "Business Combinations," which requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method. The pooling-of-interests method of accounting is prohibited except for combinations initiated before June 30, 2001. The remaining provisions of SFAS No. 141 relating to business combinations accounted for by the purchase method, including identification of intangible assets, accounting for negative goodwill, financial statement presentation and disclosure, are effective for combinations completed after June 30, 2001. Management will follow the provisions of SFAS No. 141 for any acquisitions initiated after June 30, 2001. In June 2001, the FASB issued SFAS No. 142 "Goodwill and Intangible Assets," which prescribed accounting for all purchased goodwill and intangible assets. Pursuant to SFAS No. 142, acquired goodwill is not amortized, but is tested for impairment at the reporting unit level annually and whenever an impairment indicator arises. All goodwill should be assigned to reporting units that are expected to benefit from the goodwill. When an 37 entity reorganizes its reporting structure, goodwill should be reallocated to reporting units based on the relative fair values of the units. Goodwill impairment should be tested with a two-step approach. First, the fair value of the reporting unit should be compared to its carrying value, including goodwill. If the reporting unit's carrying value exceeds its fair value, then any goodwill impairment should be measured as the excess of goodwill's carrying value over its implied fair value. The implied fair value of goodwill should be calculated in the same manner as goodwill is calculated for a business combination, using the reporting unit's fair value as the "purchase price" over the amounts allocated to assets, including unrecognized intangible assets, and liabilities of the reporting unit. Goodwill impairment losses should be reported in the income statement as a separate line item within operations, except for such losses included in the calculation of a gain or loss from discontinued operations. An acquired intangible asset, other than goodwill, should be amortized over its useful economic life. The useful life of an intangible asset is indefinite if it extends beyond the foreseeable horizon. If an asset's life is indefinite, the asset should not be amortized until the life is determined to be finite. Intangible assets being amortized should be tested for impairment in accordance with SFAS No. 121. Intangible assets not being amortized should be tested for impairment annually and whenever there are indicators of impairment, by comparing the asset's fair value to its carrying amount. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. SFAS No. 142 will have no current effect on our financial position or results of operations. During the second quarter of 2002, we completed our initial analysis of potential impairment under the provisions of SFAS No. 142, and determined based on that analysis that goodwill was not impaired. Goodwill will be tested for impairment annually, or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. We had no goodwill related to acquisitions initiated prior to July 1, 2001, or other intangible assets recorded prior to the adoption of the provisions of SFAS No. 142 whose carrying amounts or amortization were changed by the adoptions of the provisions of SFAS No. 142. In June 2001, the FASB also issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. Management does not expect the adoption of this pronouncement to have a material impact on our results of operations or financial condition. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001. The standard addresses financial accounting and reporting for the impairment or disposal of long-lived assets. The adoption of this pronouncement did not have a material impact on our results of operations or financial condition. 38 BUSINESS OF CITIZENS SOUTH BANKING CORPORATION AND CITIZENS SOUTH BANK General Citizens South Banking Corporation Citizens South Banking Corporation was formed on March 18, 1998, for the purpose of acting as the holding company for Citizens South Bank. Our assets consist primarily of the outstanding capital stock of Citizens South Bank, deposits held at Citizens South Bank, and investment securities. As of March 31, 2002, 1,752,427 shares of our common stock were held by the public and 2,457,007 shares were held by Citizens South Holdings, MHC, our parent mutual holding company. Our publicly held common stock currently trades on the Nasdaq National Market under the symbol CSBC. Our principal business is overseeing and directing the business of Citizens South Bank and investing the net stock offering proceeds retained by Citizens South Banking Corporation. Our executive office is located at 245 West Main Avenue, P.O. Box 2249, Gastonia, North Carolina 28053-2249. Our telephone number at this address is (704) 868-5200. Citizens South Bank Citizens South Bank, which was chartered in 1904, is a community bank engaged primarily in the business of offering FDIC-insured deposits to customers through its branch offices and investing those deposits, together with funds generated from operations and borrowings, in residential, commercial, construction and consumer loans, investment securities, and mortgage-backed securities. Our results of operations are dependent primarily on net interest income, which is the difference between the income earned on its loan and securities portfolios and its cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by our provision for loan losses, sales of assets, fee income generated from our deposit and loan accounts, and commissions on the sale of uninsured investment products. Our noninterest expense primarily consists of compensation and employee benefits, occupancy expense, professional services, advertising, and other noninterest expenses. Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates and actions of regulatory and governmental authorities. On March 11, 2002, Gaston Federal Bank changed its name to Citizens South Bank following the acquisition of three banking offices located outside of Gaston County, North Carolina. Our corporate headquarters and five branch offices are located in Gaston County, North Carolina, which is located in the I-85 corridor, approximately 20 miles west of the regional banking center of Charlotte, North Carolina. We also operate two branch offices in Rowan County, North Carolina, and one branch office in Iredell County, North Carolina. These offices are located approximately 60 miles northeast of the corporate headquarters. We consider our primary market area to be the North Carolina Counties of Gaston, Rowan, Iredell, Mecklenburg, Cabarrus, Lincoln and Cleveland, and the South Carolina County of York. Our executive office is located at 245 West Main Avenue, P.O. Box 2249, Gastonia, North Carolina 28053-2249. Citizens South Bank's telephone number at this address is (704) 868-5200. Acquisition of Innes Street Financial Corporation On December 31, 2001, we acquired 100% of the outstanding shares of common stock of Innes Street Financial Corporation and its wholly owned subsidiary, Citizens Bank, Inc. As part of the acquisition, Innes Street Financial Corporation's stockholders received a cash payment of $18.50 per share for each share of Innes Street common stock issued and outstanding. The aggregate cash purchase price for the transaction was approximately $38 million. As part of the acquisition, Citizens Bank, Inc. was merged into Citizens South Bank (Gaston Federal Bank at the time of the acquisition). Because the acquisition occurred on December 31, 2001, the assets and liabilities of Innes Street Financial Corporation are included in our consolidated statements of condition at December 31, 2001. However, the results of operations of Innes Street Financial Corporation are not included in our consolidated financial statements for the year ended December 31, 2001 (they are included in our financial statements for the period beginning after completion of the acquisition). Beginning at page G-1 of this prospectus, we have presented consolidated financial statements for Innes Street Financial Corporation for the twelve months ended September 30, 2000 and 1999 and for the nine months ended June 30, 2001, as well as unaudited pro forma 39 condensed combined statements of financial condition as of September 30, 2001 and statements of operations for the nine months ended September 30, 2001 and for the twelve months ended December 31, 2000. The unaudited pro forma condensed statements of operations give effect to the acquisition using the purchase method of accounting and assume that the acquisition occurred at the beginning of the respective periods presented. Innes Street Financial Corporation and its subsidiary served the Salisbury, North Carolina area for 94 years by providing that community and the surrounding counties with general banking services. Citizens Bank operated three full-service branch offices in Salisbury, North Carolina, Statesville, North Carolina, and Rockwell, North Carolina. At the time of the acquisition, Innes Street Financial Corporation had total assets of $221.8 million, net loans of $170.5 million, total deposits of $175.4 million, and total liabilities of $183.8 million. The transaction was accounted for using the purchase method of accounting. Accordingly, intangible assets of $9.5 million were recognized in conjunction with the acquisition. These intangible assets include $6.6 million in goodwill, a $2.4 million core deposit premium, which is being amortized over a seven year period on an accelerated basis, and $425,000 in mortgage servicing rights, which is being amortized over the excepted life of the asset. Business Strategy Our business strategy is to grow and enhance our profitability by (1) acquiring other financial institutions or branches as opportunities arise, (2) reducing reliance on net interest income by increasing fee income from our products and services, (3) improving net interest margin through a combination of reduced funding costs and improved loan pricing, (4) maintaining high asset quality, and (5) continuing to emphasize operating efficiencies and cost control. Acquiring other financial institutions or financial services companies. Significant consolidation has taken place within the financial institutions sector during the past two decades. Consolidation is expected to continue, especially in geographic areas such as North Carolina that continue to have an abundance of financial institutions. Upon completion of the conversion, our new corporate structure will enable us to be more competitive in pursuing acquisitions of other financial institutions, branches, or financial services companies. We currently have no specific plans, arrangements or understandings regarding any such acquisitions. Increasing fee income from products and services. Through our acquisition of Innes Street in December 2001, we substantially increased our commercial business lending. We hope to leverage these relationships by increasing fee income from products and services, particularly corporate checking account products, to these customers. In addition, by deploying a portion of the net proceeds from the offering into expanded loan originations, we expect to increase fee income from this source as well. Finally, we expect to continue to increase sales of fee-generating financial products by Citizens South Financial Services, Inc., doing business as Citizens South Investment Services, our service corporation. Improving net interest margin through reduced funding costs and improved loan pricing. As noted above, our acquisition of Innes Street has resulted in increased transaction accounts, such as commercial checking accounts, which generally result in reduced funding costs. In addition, we will seek to become the "lender of choice" for commercial borrowers in our market area, and increase the yield available from lending to these customers by competing aggressively in non-price areas, such as high quality service. Maintaining high asset quality. Although our loan portfolio includes loans (multi-family and commercial real estate mortgage loans, construction loans and commercial business loans) that are considered higher risk loans than one- to four-family mortgage loans, we have consistently maintained a high level of asset quality. As of March 31, 2002, we had $3.2 million of nonperforming assets (0.71% of total assets) and $1.5 million of nonperforming loans (0.43% of total loans). During the years ended December 31, 2001 and 2000, we charged off loans totaling $104,000 and $4,000, respectively. Continuing emphasis on operating efficiencies and cost control. Our ratio of noninterest expense to average total assets was 2.73% for the three months ended March 31, 2002 and 2.70% for the twelve months ended December 31, 2001. Excluding the amortization of intangible assets, our ratio of noninterest expense to average total assets was 2.42% for the three months ended March 31, 2002 and 2.70% for the twelve months ended 40 December 31, 2001. We plan to continue to monitor and control costs, although we recognize that our business strategies will require greater investments in personnel, marketing, premises and equipment. Competition We face significant competition both in making loans and in attracting deposits. The Charlotte-Gastonia-Rock Hill, North Carolina-South Carolina Metropolitan Statistical Area has a high density of financial institutions, many of which are branches of significantly larger institutions which have greater financial resources than Citizens South Banking Corporation, and all of which are our competitors to varying degrees. Our competition for loans comes principally from commercial banks, savings banks, savings and loan associations, mortgage banking companies, credit unions, insurance companies and other financial service companies. Our most direct competition for deposits has historically come from commercial banks, savings banks, savings and loan associations and credit unions. We face additional competition for deposits from non-depository competitors such as the mutual fund industry, securities and brokerage firms and insurance companies. Market Area Our corporate headquarters and five branch offices are located in Gaston County, North Carolina, which is located in the I-85 corridor, approximately 20 miles west of the regional banking center of Charlotte, North Carolina. Gaston County has a population of approximately 200,000, and has an economy based on manufacturing, textiles, apparel, fabricated metals, machinery, chemicals, and automotive transportation equipment, and has developed a strong base in service industries, especially construction and retail trade. Among the largest employers in Gaston County are Freightliner, Firestone, Parkdale Mills, Pharr Yarns, Dana Corporation, Gaston Memorial Hospital and Gaston College. We also operate two branch offices in Rowan County, North Carolina, and one branch office in Iredell County, North Carolina. These offices are located approximately 60 miles northeast of the corporate headquarters. Rowan County has a population of approximately 130,000 and Iredell County has a population of approximately 123,000. Among the largest employers in Rowan County are Food Lion, Freightliner, KoSa, the Rowan/Salisbury Schools, Heafner VA Medical Center, and Rowan Regional Medical Center. Among the largest employers in Iredell County are ASMO North Carolina (electric motors), Lowe's Regional Distribution Center, Dana Spicer Off-Highway Products (axles and gears), the Iredell-Statesville Schools, Iredell Memorial Hospital, and Davis Regional Medical Center. We consider our primary market area to be the North Carolina Counties of Gaston, Rowan, Iredell, Mecklenburg, Cabarrus, Lincoln, and Cleveland, and the South Carolina County of York. Future Acquisitions and Expansion Activity Both nationally and in North Carolina, the banking industry is undergoing a period of consolidation marked by numerous mergers and acquisitions. Although we do not have a formal program to acquire other financial institutions, we may from time to time be presented with opportunities to acquire institutions or bank branches that could expand and strengthen our market position. If such an opportunity arises, we may from time to time engage in discussions or negotiations and we may conduct a business investigation of a target institution. Acquisitions typically involve the payment of a premium over book and market values and, therefore, some dilution of our book value and net income per share may occur in connection with a future acquisition. Lending Activities General. At March 31, 2002, our net loans receivable totaled $323.5 million, or 72.6% of total assets at that date. In the past, we concentrated our lending activities on conventional first mortgage loans secured by one- to four-family properties. Currently, in addition to these loans, we emphasize residential construction loans, commercial real estate loans, commercial business loans and consumer loans. A substantial portion of our loan portfolio is secured by real estate, either as primary or secondary collateral, located in our primary market area. 41 Loan Portfolio Analysis. The following table sets forth the composition of Citizens South Bank's loan portfolio at the dates indicated. We had no concentration of loans exceeding 10% of total gross loans other than as disclosed below.
March 31, December 31, ------------------------------------ ------------------------------------ 2002 2001 2001 2000 ---------------- ---------------- ---------------- ---------------- Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- (Dollars In Thousands) Real estate loans: One- to four-family residential ...... $187,086 56.30% $101,914 59.76% $196,572 57.33% $109,907 66.43% Multi-family residential ...... 9,016 2.71 1,755 1.03 8,696 2.54 2,003 1.21 Construction ....... 15,468 4.66 9,891 5.80 16,525 4.82 9,597 5.80 Nonresidential ..... 23,921 7.20 4,989 2.92 28,543 8.33 6,190 3.74 ------- ------ -------- ------ -------- ------ -------- ------- Total real estate loans .......... 235,491 70.87 118,549 35.68 250,336 73.02 127,697 77.19 Commercial business loans ............ 31,198 9.39 30,937 18.14 27,622 8.06 19,569 11.83 Consumer loans: Home equity lines of credit ........ 47,123 14.18 16,896 9.91 46,941 13.69 15,671 9.47 Other .............. 18,470 5.56 4,164 2.44 17,942 5.23 2,512 1.52 ------- ------ -------- ------ -------- ------ -------- ------- Total consumer loans .......... 65,593 19.74 21,060 12.35 64,883 18.92 18,183 10.99 ------- ------ -------- ------ -------- ------ -------- ------- Total loans ......... 332,282 100.00% 170,546 100.00% 342,841 100.00% 165,449 100.00% ====== ====== ====== ======= Less: Loans in process ... 5,649 3,959 5,306 4,758 Deferred loan fees, net .............. 83 292 78 305 Allowance for loan losses ........... 3,022 1,522 3,136 1,566 ------- -------- -------- -------- Total loans, net .... $323,528 $164,773 $334,321 $158,820 ======== ======== ======== ======== September 30, ---------------------------------------------------------------------------- 2000 1999 1998 1997 ---------------- ---------------- ---------------- ---------------- Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- Real estate loans: One- to four-family residential ...... $129,031 70.36% $129,332 73.42% $105,526 73.50% $106,422 76.50% Multi-family residential ...... 2,046 1.12 2,414 1.37 3,771 2.63 6,514 4.68 Construction ....... 6,939 3.78 8,513 4.83 10,573 7.36 5,869 4.22 Nonresidential ..... 6,469 3.53 7,266 4.13 8,076 5.63 7,318 5.26 -------- ------ -------- ------ -------- ------ -------- ------ Total real estate loans .......... 144,485 78.78 147,525 83.75 127,946 89.12 126,123 90.66 Commercial business loans ............ 21,716 11.85 17,019 9.67 6,629 4.62 5,558 4.00 Consumer loans: Home equity lines of credit ........ 14,197 7.74 8,867 5.03 6,764 4.71 5,651 4.07 Other .............. 2,971 1.62 2,732 1.55 2,225 1.55 1,779 1.27 -------- ------ -------- ------ -------- ------ -------- ------ Total consumer loans .......... 17,168 9.36 11,599 6.58 8,989 6.26 7,430 5.34 -------- ------ -------- ------ -------- ------ -------- ------ Total loans ......... 183,369 100.00% 176,143 100.00% 143,564 100.00% 139,111 100.00% ====== ====== ====== ====== Less: Loans in process ... 4,544 6,205 5,152 2,990 Deferred loan fees, net .............. 325 385 501 520 Allowance for loan losses ........... 1,537 1,509 1,411 1,110 -------- -------- -------- -------- Total loans, net .... $176,963 $168,044 $136,500 $134,491 ======== ======== ======== ========
42 One-to Four-Family Real Estate Lending. At March 31, 2002, our one- to four-family residential loan portfolio totaled $187.1 million, or 56.3% of our total loan portfolio. These loans are typically originated under terms, conditions and documentation that permit them to be sold to U.S. Government-sponsored agencies such as Freddie Mac. These loans customarily include "due on sale" clauses, which give us the right to declare a loan immediately due and payable in the event the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not paid. Our one- to four-family mortgage loans generally have maturities ranging from ten to thirty years and are fully amortizing with monthly or bi-weekly payments sufficient to repay the total amount of the loan with interest by the end of the loan term. We require title insurance insuring the status of our lien or an acceptable attorney's opinion on all first mortgage loans where real estate is the primary source of security. We also require that fire and casualty insurance (and, if appropriate, flood insurance) be maintained in an amount at least equal to the outstanding loan balance. Pursuant to underwriting guidelines adopted by our Board of Directors, we can lend up to 95% of the appraised value of the property securing a one- to four-family residential loan. For loans that have a loan-to-value (LTV) ratio of more than 80%, we require private mortgage insurance for between 20% and 30% of the amount of the loan. We do not require private mortgage insurance for loans that have a LTV ratio of 80% or less. We offer both fixed and adjustable rate mortgage loans at competitive rates and terms. Our adjustable-rate mortgage (ARM) loans typically provide for an interest rate which adjusts every year after an initial term of three or five years based on the one year Treasury constant maturity index and are typically based on a 30-year amortization schedule. Our current ARM loans do not provide for negative amortization. Our ARM loans generally provide for annual and lifetime interest rate adjustment limits of 2% and 5%, respectively. The retention of ARM loans in our loan portfolio helps reduce our exposure to changes in interest rates. There are, however, unquantifiable credit risks resulting from the potential of increased costs due to changed rates to be paid by the customer. It is possible that during periods of rising interest rates the risk of default on ARM loans may increase as a result of repricing and the increased payments required by the borrower. In addition, although ARM loans allow us to increase the sensitivity of our asset base to changes in the interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits. Because of these considerations, we have no assurance that yields on ARM loans will be sufficient to offset increases in our cost of funds. We believe these risks, which have not had a material adverse effect on us to date, generally are less than the risks associated with holding fixed-rate loans in portfolio during a rising interest rate environment. In 1999, we began originating and selling substantially all fixed rate mortgages to investors on a servicing released basis. This allows us to provide competitive mortgage products to our market area including 15- and 30-year fixed-rate loans and long-term fixed-rate Federal Housing Administration (FHA) and Veterans Administration (VA) products. Our sale of mortgage loans at origination helps us manage our interest rate risk. We also benefit by being able to immediately record fee income we earn on these loans during the period in which the loan is sold. Multifamily Residential Real Estate Lending. At March 31, 2002, our multifamily residential real estate (more than four units) loan portfolio totaled $9.0 million, or 2.7% of our total loan portfolio. The majority of our multifamily residential real estate loans are secured by apartment buildings located in our primary market area. The interest rates for our multifamily residential real estate loans generally have interest rates that adjust at either one-, three-, or five-year intervals, based on the constant maturity Treasury index, with annual and lifetime interest rate adjustment limits of 2% and 5%, respectively, or adjust based on our prime rate, and are originated to amortize in a maximum of 20 years. We require appraisals of all properties securing multifamily residential real estate loans. Appraisals are performed by State-licensed or certified independent appraisers designated by us, all of whom are reviewed by management. We consider the quality and location of the real estate, the credit of the borrower, the cash flow of the project and the quality of management involved with the property. LTV ratios on our multifamily residential real estate loans are generally limited to 80%. As part of the criteria for underwriting multifamily residential real estate loans, we generally require a debt coverage ratio (the ratio of net cash from operations before payment of debt service to debt service) of not less than 1.25. We generally obtain personal guarantees from the principals of our corporate borrowers on multifamily residential real estate loans. Multifamily residential real estate lending affords us an opportunity to receive interest at rates higher than those generally available from one- to four-family residential lending. However, loans secured by such properties usually have higher balances and are more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than one- to four-family residential mortgage loans. If the estimate of value proves to be inaccurate, in the 43 event of default and foreclosure we may be confronted with a property that has insufficient value to assure full repayment. Because payments on such loans are often dependent on the successful operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. We seek to minimize these risks by limiting the maximum LTV ratio and strictly scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. Construction Lending. At March 31, 2002, total construction loans amounted to $15.5 million, or 4.7% of our total loan portfolio. We generally originate residential construction-permanent loans to individuals who have a contract with a builder for the construction of their residence and speculative construction loans to local builders for purposes of building one- to four-family residential properties. Prior to making a commitment to fund a construction loan, we require an appraisal of the property by an independent state-licensed and qualified appraiser approved by the Board of Directors. Our staff, or an independent appraiser retained by us, reviews and inspects each project prior to disbursement of funds during the term of the construction loan. Loan proceeds are disbursed after inspection of the project based on a percentage of completion. Monthly payment of accrued interest is required during the construction period. Our construction-permanent loans are typically made in connection with the granting of the permanent financing on the property. These loans convert to a fully amortizing three or five year adjustable- or fixed-rate loan at the end of the 12-month construction term. If the construction is not complete after 12 months, we will generally modify the loan so that the term is for a period necessary to complete construction. These loans are generally originated pursuant to the same policies regarding loan-to-value ratios and credit quality as are used in connection with loans secured by existing one- to four-family residential real estate. Our speculative construction loans are typically granted to local builders with an established relationship with us. These loans are typically for a term of 12 months at an interest rate tied to our prime lending rate. If the property is not sold at the end of the 12-month term, we will generally extend the loan for a reasonable period necessary to sell the property. These loans are underwritten based on the financial strength of the builder. We generally obtain a personal guarantee from the builder. In order to reduce our exposure, builders are typically limited in the number of outstanding unsold properties they may have with us at any one time. Construction lending affords us the opportunity to charge higher interest rates relative to permanent residential lending. However, construction lending is generally considered to involve a higher degree of risk than permanent residential lending because of the inherent difficulty in estimating a property's value at the completion of the construction. The nature of these loans is such that they are generally more difficult to evaluate and monitor. If the estimate of construction cost proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion proves to be inaccurate, we may be confronted at or prior to the maturity of the loan with a property that has insufficient value to collateralize the loan. Projects may also be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors. We have attempted to minimize the foregoing risks by, among other things, limiting our construction lending primarily to residential properties located within our market area, requiring lien waivers from contractors prior to making disbursements, and holding back a portion of the loan proceeds until construction is complete. Nonresidential Real Estate Lending. At March 31, 2002, our nonresidential real estate loans totaled $23.9 million, or 7.2% of our total loan portfolio. We originate mortgage loans for the acquisition and refinancing of nonresidential real estate properties and land. The majority of our nonresidential real estate properties are secured by office buildings, churches, retail shops, and land which are generally located in our primary market area. These loans generally have interest rates that adjust at either one-, three-, or five-year intervals, based on the constant maturity Treasury index, with annual and lifetime interest rate adjustment limits of 2% and 5%, respectively, adjust based on our prime rate, and are originated to amortize in a maximum of 20 years or are for a fixed rate for a period of generally five years with a maximum amortization of 20 years. We require appraisals of all properties securing nonresidential real estate loans. Appraisals are performed by State-certified independent appraisers designated by us, all of whom are reviewed by management. We consider the quality and location of the real estate, the credit of the borrower, the cash flow of the project and the quality of management involved with the property. Loan-to-value ratios on our nonresidential real estate loans are generally limited to 80% of the appraised value of the secured 44 property. As part of the criteria for underwriting nonresidential real estate loans, we generally require a debt coverage ratio (the ratio of net cash from operations before payment of debt service to debt service) of not less than 1.25. It is also our policy to obtain personal guarantees from the principals of our corporate borrowers on our commercial real estate loans. This type of lending affords us an opportunity to receive interest at rates higher than those generally available from one- to four-family residential lending. However, loans secured by such properties usually have higher balances and are more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than residential mortgage loans. If the estimate of value proves to be inaccurate, in the event of default and foreclosure we may be confronted with a property the value of which is insufficient to assure full repayment. Because payments on such loans are often dependent on the successful development, operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. We seek to minimize these risks by limiting the maximum LTV ratio and strictly scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. We also obtain loan guarantees from financially capable parties based on a review of personal financial statements. Commercial Business Loans. At March 31, 2002, we had $31.2 million of commercial business loans, representing 9.4% of the total loan portfolio. We originate commercial business loans to customers who are generally well known to us and are located in our primary market area. Commercial business loans may be either unsecured or secured by collateral other than real estate, such as vehicles, equipment, stock, etc. The decision to grant a commercial business loan depends primarily on the creditworthiness and cash flow of the borrower and any guarantors. The interest rates for our commercial business loans generally adjust based on our prime rate, or are fixed at the time of closing for a term of generally five to seven years. We generally require annual financial statements from our corporate borrowers and personal guarantees from the corporate principals. We also generally require an estimate of value for any collateral that secures the loan. Unsecured commercial business loans totaled $3.4 million as of March 31, 2002. Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with residential and commercial real estate lending. Commercial business loans are often unsecured or secured by equipment or other business assets. The liquidation of collateral in the event of a borrower default is often an insufficient source of repayment because equipment and other business assets may be obsolete or of limited use. Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower and any guarantors, while liquidation of collateral is a secondary and often insufficient source of repayment Home Equity Lines of Credit. At March 31, 2002, our home equity line of credit portfolio totaled $47.1 million, or 14.2% of the total loan portfolio. Our home equity lines of credit (HELOCs) are secured by a first or second mortgage on residential property, have variable interest rates that are tied to The Wall Street Journal prime lending rate (the "prime rate") and may adjust monthly, and generally mature in 15 years. The maximum LTV ratio on these loans is typically 90%, including the outstanding balance of any superior liens. Unused commitments to extend credit under these HELOCs totaled $42.3 million as of March 31, 2002. HELOCs originated by us are typically secured by properties located in our normal lending area or to customers who have a relationship with us. These loans are generally underwritten to the same credit standards used when underwriting first mortgage loans. We also generally require title insurance and an independent estimate of value. HELOCs obtained from the acquisition of Innes Street were generally originated using a third party Internet loan provider. These loans, which are secured by properties located in North Carolina, Georgia, and Virginia, were underwritten based on the applicant's credit history and the value of the collateral. Our lien position on these loans is covered by either a title insurance policy or signed affidavit from the borrower verifying our lien position. Other Consumer Lending. At March 31, 2002, other consumer loans amounted to $18.5 million, or 5.6% of the total loan portfolio. We originate a variety of consumer loans including second mortgage loans, loans secured by savings accounts, automobiles, recreational vehicles, and unsecured personal loans. The largest component of other consumer loans is second mortgage loans. Most of these loans were second mortgage loans obtained from the acquisition of Innes Street and were generally originated using a third party internet loan provider. These loans, which are secured by properties located in North Carolina, Georgia, and Virginia, were underwritten based on the 45 applicant's credit history and the value of the collateral. These loans typically have a fixed rate of interest and generally mature in 15 years. The maximum LTV ratio is 90%, including the outstanding balance of any superior liens. Our lien position on these loans is covered by either a title insurance policy or a signed affidavit from the borrower verifying our lien position. Most of our other consumer loans are made to existing customers, although we actively promote consumer loans by promotions and advertising directed at existing and prospective customers. We view consumer lending as an important part of our business because consumer loans generally have shorter terms and higher yields, thus reducing exposure to changes in interest rates. In addition, we believe that offering consumer loans helps to expand and create stronger ties to our customer base. Subject to market conditions, we intend to continue emphasizing consumer lending. Consumer loans not secured by real estate are made with fixed interest rates and have terms that generally do not exceed five years. Consumer loans entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by rapidly depreciating assets. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. We employ strict underwriting procedures for consumer loans. These procedures include an assessment of the applicant's credit history and the ability to meet existing and proposed debt obligations. Although the applicant's creditworthiness is the primary consideration, the underwriting process also includes an evaluation of the proposed collateral for the loan. We underwrite and originate our consumer loans internally, which we believe limits our exposure to credit risks associated with loans underwritten or purchased from brokers and other external sources. Maturity of Loan Portfolio. The following table sets forth certain information at December 31, 2001 regarding the dollar amount of loans maturing in our portfolio based on their contractual terms to maturity, but does not include scheduled payments or potential prepayments. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as becoming due within one year. Loan balances do not include undisbursed loan proceeds, unearned discounts, unearned income and allowance for loan losses.
Real Estate Loans ----------------------------------------------------------- One- to Four- Commercial Family Multi-Family Business and Residential Residential Construction Non-Residential Consumer Total ------------- ------------ ------------ --------------- ------------ --------- Amounts Due: Within 1 year ............. $ 2,987 $ -- $ 10,666 $ 2,620 $ 9,209 $ 25,482 Over 1 to 2 years ......... 947 -- -- 807 7,567 9,321 Over 2 to 3 years ......... 1,217 -- -- 1,163 2,637 5,017 Over 3 to 5 years ......... 6,469 110 -- 3,879 5,532 15,990 Over 5 to 10 years ........ 31,487 3,424 -- 5,038 8,746 48,695 Over 10 to 20 years ....... 73,116 5,162 3,102 14,895 51,368 147,643 Over 20 years ............. 80,349 -- 2,757 141 7,446 90,693 --------- ---------- ---------- ----------- ---------- --------- Total amount due .......... $ 196,572 $ 8,696 $ 16,525 $ 28,543 $ 92,505 $ 342,841 ========= ========== ========== =========== ========== =========
46 The following table sets forth the dollar amount of all loans for which final payment is not due until after December 31, 2002. The table also shows the amount of loans which have fixed rates of interest and those which have adjustable rates of interest.
Fixed Rates Adjustable Rates Total ------------- ------------------ ------------ (In Thousands) Real Estate Loans: One- to four-family residential ............. $ 109,335 $ 84,250 $ 193,585 Multifamily residential ..................... 5,750 2,946 8,696 Construction ................................ 3,313 2,546 5,859 Commercial real estate ...................... 9,821 16,102 25,924 ------------ -------------- ------------ Total real estate loans ....................... 128,219 105,844 234,064 Commercial and consumer ....................... 22,984 60,311 83,295 ------------ -------------- ------------ Total loans ................................. $ 151,203 $ 166,155 $ 317,359 ============ ============== ============
Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of a loan is substantially less than its contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally give us the right to declare loans immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase, however, when current mortgage loan market rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans are substantially lower than current mortgage loan market rates. Furthermore, management believes that a significant number of our residential mortgage loans are outstanding for a period less than their contractual terms because of the transitory nature of many of the borrowers who reside in our primary market area. Loan Solicitation and Processing. Our lending activities are subject to the written, non-discriminatory, underwriting standards and loan origination procedures established by management and approved by our Board of Directors. Loan originations come from a number of sources. The customary sources of loan originations are real estate agents, home builders, walk-in customers, referrals and existing customers. Loan officers also call on local businesses soliciting commercial products. We advertise our loan products in various print media including the local newspapers. In our marketing, we emphasize our community ties, customized personal service and an efficient underwriting and approval process. We use professional fee appraisers for most residential real estate loans and construction loans and all commercial real estate and land loans. On new loan originations, we require hazard, title and, to the extent applicable, flood insurance on all security property. The Board of Directors must approve all loans of $1.0 million or more, or in any amount to borrowers with existing exposure to us of $1.0 million or more, or in any amount that when added to the borrower's existing exposure to us cause such total exposure to be $1.0 million or more. In addition, the Board of Directors must approve all unsecured loans of $400,000 or more. Loans of less than $1.0 million, or customers with exposure (including the proposed loan) of less than $1.0 million, or unsecured loans of less than $400,000, as applicable, may be approved individually or jointly by our lending officers within loan approval limits delegated by the Board of Directors. In addition, the Board of Directors has delegated "incremental" loan approval limits to certain lending officers which allows them to approve a new loan to an existing customer in an amount equal to, or less than, their incremental loan limit that would otherwise require approval by the Board of Directors or the additional approval of another lending officer. Any loan approved by a lending officer using their incremental loan limit must be ratified by the Board of Directors or approved by another lending officer, as applicable, after the loan has been made. 47 Loan Originations, Sales and Purchases. The following table sets forth total loans originated and repaid during the periods indicated.
At and For the Twelve Months Ended For the Three Months ------------------------------------------------ Ended March 31, December 31, September 30, ----------------------- ----------------------- ---------------------- 2002 2001 2001 2000 2000 1999 ---------- ---------- ---------- ---------- ---------- ---------- (In Thousands) Total loans receivable at beginning of period ..... $ 334,321 $ 158,820 $ 158,820 $ 169,931 $ 176,143 $ 143,564 Total loan originations: One- to four-family residential ................ 2,279 132 1,419 3,700 4,951 17,427 Construction ................................... 3,127 2,537 8,849 3,800 2,716 8,552 Commercial real estate ......................... 2,750 2,707 6,146 -- -- -- Multifamily .................................... 500 35 -- -- -- 150 Commercial business ............................ 2,651 8,923 29,938 26,289 26,268 22,801 Consumer ....................................... 11,374 4,867 22,119 19,485 18,083 4,433 ---------- ---------- ---------- ---------- ---------- ---------- Total loans originated ............................ 22,681 19,201 68,471 53,274 52,018 53,363 Loans purchased ................................... -- -- 170,527 -- 20 38,262 Loans sold ........................................ (1,311) -- -- (18,169) (215) (13,136) Principal repayments .............................. (32,163) (13,248) (63,497) (46,216) (44,597) (45,910) ---------- ---------- ---------- ---------- ---------- ---------- Net loan activity ................................. (10,793) 5,953 175,501 (11,111) 7,226 32,579 ---------- ---------- ---------- ---------- ---------- ---------- Total loans receivable at end of period ........... $ 323,528 $ 164,773 $ 334,321 $ 158,820 $ 183,369 $ 176,143 ========== ========== ========== ========== ========== ==========
Loan Commitments. We issue commitments for mortgage loans conditioned upon the occurrence of certain events. Such commitments are made in writing on specified terms and conditions and are honored for up to 60 days from approval, depending on the type of transaction. At March 31, 2002, we had loan commitments (excluding undisbursed portions of interim construction loans of $5.6 million) of $4.9 million and unused commercial lines of credit of $12.0 million and unused home equity lines of credit of $42.3 million. Loan Fees. In addition to interest earned on loans, we receive income from fees in connection with loan originations, loan modifications, late payments and for miscellaneous services related to its loans. Income from these activities varies from period to period depending upon the volume and type of loans made and competitive conditions. We charge loan origination fees which are generally calculated as a percentage of the amount borrowed. In accordance with applicable accounting standards, loan origination fees and discount points in excess of loan origination costs are deferred and recognized over the contractual remaining lives of the related loans on a level yield basis. Discounts and premiums on loans purchased are accreted and amortized in the same manner. Fees collected on loans originated and sold to investors are recognized in the period in which the loan is sold. We recognized $48,000, $25,000, $106,000, $101,000, $108,000 and $232,000 of deferred loan fees during the three months ended March 31, 2002 and 2001 and during the fiscal years ended December 31, 2001, December 31, 2000, September 30, 2000, and September 30, 1999, respectively, in connection with loan refinancings, payoffs, sales and ongoing amortization of outstanding loans. Nonperforming Assets and Delinquencies. When a borrower fails to make a required payment on a loan, we attempt to cure the deficiency by contacting the borrower and collecting the payment. Computer generated late notices are mailed 15 days after a payment is due. In most cases, deficiencies are cured promptly. If a delinquency continues, additional contact is made either through a notice, telephone call, or other means and we will attempt to work out a payment schedule and actively encourage delinquent borrowers to seek home ownership counseling. While we generally prefer to work with borrowers to resolve such problems, we will institute foreclosure or other proceedings, as necessary, to minimize any potential loss. Loans are placed on nonaccrual status generally if, in the opinion of management, principal or interest payments are not likely in accordance with the terms of the loan agreement, or when principal or interest is past due 90 days or more. Interest accrued but not collected at the date the loan is placed on nonaccrual status is reversed against income in the current period. Loans may be reinstated to accrual status when payments are under 90 days past due and, in the opinion of management, collection of the remaining past due balances can be reasonably expected. Our Board of Directors is informed monthly of the total number and amount of loans that are more than 30 days delinquent. Loans that are more than 90 days delinquent or in foreclosure are reviewed by the Board on an individual basis each month. 48 The following table sets forth information with respect to our nonperforming assets at the dates indicated. As of such dates, we had no restructured loans within the meaning of SFAS No. 15.
March 31, December 31, September 30, --------- ------------------- ------------------------------------------- 2002 2001 2000 2000 1999 1998 1997 --------- -------- -------- -------- -------- -------- -------- (Dollars in Thousands) Loans accounted for on a nonaccrual basis: Real estate loans: One- to four-family residential ........... $ 778 $ 592 $ 236 $ 211 $ 94 $ 970 $ 876 Multifamily residential ................... 101 70 71 -- -- 177 183 Commercial real estate .................... 293 -- -- -- -- 91 -- Commercial business .......................... 271 150 75 -- -- -- -- Consumer loans ............................... 9 24 97 46 -- -- -- -------- -------- -------- -------- -------- -------- -------- Total nonaccrual loans ....................... 1,452 836 479 257 94 1,238 1,059 Total nonperforming loans .................... 1,452 836 479 257 94 1,238 1,059 Real estate owned ............................ 1,699 1,470 -- -- 259 247 247 -------- -------- -------- -------- -------- -------- -------- Total nonperforming assets ................... $ 3,151 $ 2,306 $ 479 $ 257 $ 353 $ 1,485 $ 1,306 ======== ======== ======== ======== ======== ======== ======== Nonaccrual loans and loans 90 days past due as a percentage of net loans ............... 0.45% 0.25% 0.30% 0.15% 0.06% 0.91% 0.79% Nonaccrual loans and loans 90 days past due as a percentage of total assets ............ 0.33% 0.19% 0.19% 0.11% 0.04% 0.60% 0.61% Total nonperforming assets as a percentage of total assets ............................ 0.71% 0.52% 0.19% 0.11% 0.15% 0.71% 0.75%
Interest income that would have been recorded for the three months ended March 31, 2002 and for the twelve months ended December 31, 2001 had nonaccruing loans been current in accordance with their original terms amounted to $36,000 and $26,000, respectively. We did not include any interest income on such loans for such periods. Real Estate Acquired in Settlement of Loans. Real estate acquired by us as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate acquired in settlement of loans until sold. Generally, foreclosed assets are held for sale and such assets are carried at fair value minus estimated cost to sell the property. After the date of acquisition, all costs incurred in maintaining the property are expensed and costs incurred for the improvement or development of such property are capitalized up to the extent of their net realizable value. At March 31, 2002, we had $1.7 million in real estate acquired in settlement of loans. The majority of this balance is comprised of one commercial office building with a net book value of $1.3 million. The property is currently available for sale and has been listed with an independent real estate sales agent. Restructured Loans. Under Generally Accepted Accounting Principles (GAAP), we are required to account for certain loan modifications or restructuring as a "troubled debt restructuring." In general, the modification or restructuring of a debt constitutes a troubled debt restructuring if we, for economic or legal reasons related to the borrower's financial difficulties, grant a concession to the borrowers that we would not otherwise consider. Debt restructurings or loan modifications for a borrower do not necessarily always constitute troubled debt restructurings, however, and troubled debt restructurings do not necessarily result in nonaccrual loans. We had no restructured loans as of March 31, 2002. Asset Classification. The OTS has adopted various regulations regarding problem assets of financial institutions. The regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, OTS examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. If an asset or portion thereof is classified as loss, the insured institution establishes specific allowances for loan losses for the full amount of the portion of the asset classified as loss. All or a portion of general loan loss allowances established to cover possible losses related to assets classified substandard or doubtful can be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital. Assets that do not 49 currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated "special mention" and monitored by us. As of March 31, 2002, the aggregate amount of our assets classified as substandard was $6.4 million and no assets were classified as doubtful or as loss. The aggregate amount designated special mention was $754,000. As of December 31, 2001, the aggregate amount of our assets classified as substandard was $4.5 million, and $150,000 was classified as doubtful. There were no assets classified as loss. The aggregate amount designated special mention was $2.9 million. Allowance for Loan Losses. We have established a systematic methodology for the determination of provisions for loan losses. The methodology is set forth in a formal policy and considers all loans in the portfolio. Specific allowances are established for certain individual loans that management considers to be impaired. The remainder of the portfolio is segmented into groups of loans with similar risk characteristics for evaluation and analysis. In originating loans, we recognize that losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions, and in the case of a secured loan, the quality of the security of the loan. We increase our allowance for loan losses by charging provisions for loan losses against our income. Management's periodic evaluation of the adequacy of the allowance is consistently applied and is based on our past loan loss experience, known losses and losses expected to have been incurred in the portfolio, particular risks inherent in the different kinds of lending that we engage in, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, current economic conditions, and other relevant internal and external factors that affect loan collectibility. Generally, a provision for loan losses is charged against income monthly to maintain the allowance for loan losses. At March 31, 2002, we had an allowance for loan losses of $3.0 million. Management believes that this amount meets the requirements for losses on loans that management considers to be impaired, for known losses and for losses incurred at the balance sheet date in the remaining loan portfolios. Although management believes that it uses the best information available to make such determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be significantly adversely affected if circumstances differ substantially from the assumptions used in making the determinations. The following table sets forth an analysis of our allowance for loan losses.
At or For the Twelve Months Ended At or For the Three --------------------------------------------------------------- Months Ended March 31, December 31, September 30, ---------------------- ------------------- ----------------------------------------- 2002 2001 2001 2000 2000 1999 1998 1997 -------- -------- -------- -------- -------- -------- -------- -------- (Dollars in Thousands) Total loans outstanding ............ $332,282 $170,546 $342,841 $165,449 $183,369 $176,143 $143,564 $139,111 ======== ======== ======== ======== ======== ======== ======== ======== Average loans outstanding .......... $330,236 $164,368 $166,574 $174,610 $174,176 $158,534 $141,322 $137,149 ======== ======== ======== ======== ======== ======== ======== ======== Allowance at beginning of period ... $ 3,136 $ 1,566 $ 1,566 $ 1,517 $ 1,509 $ 1,411 $ 1,110 $ 830 Allowance acquired in acquisition .. -- -- 1,553 -- -- -- -- -- Provision .......................... 65 30 120 52 30 105 300 293 Recoveries ......................... -- 1 1 1 1 1 5 -- Charge-offs: Consumer loans .................. (179) (75) (104) (4) (3) (8) (5) (13) -------- -------- -------- -------- -------- -------- -------- -------- Allowance at end of period ......... $ 3,022 $ 1,522 $ 3,136 $ 1,566 $ 1,537 $ 1,509 $ 1,411 $ 1,110 ======== ======== ======== ======== ======== ======== ======== ======== Allowance for loan losses as a percentage of total loans outstanding ...................... 0.91% 0.89% 0.91% 0.95% 0.84% 0.86% 0.98% 0.80% ======== ======== ======== ======== ======== ======== ======== ======== Net loans charged off as a percentage of total loans outstanding ...................... 0.05% 0.04% 0.03% --% --% --% --% 0.01% ======== ======== ======== ======== ======== ======== ======== ======== Ratio of allowance to nonperforming loans .............. 208.13% 404.79% 375.12% 326.93% 598.05% 1,605.32% 113.97% 104.82% ======== ======== ======== ======== ======== ======== ======== ========
50 The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any other category.
March 31, 2002 December 31, 2001 December 31, 2000 September 30, 2000 September 30, 1999 ------------------ ------------------ ------------------ ------------------ ------------------ Percent Percent Percent Percent Percent of Loans of Loans of Loans of Loans of Loans in in in in in Each Each Each Each Each Category Category Category Category Category to Total to Total to Total to Total to Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- (Dollars In Thousands) Real estate loans: One- to four-family residential ............ $ 700 56.30% $ 800 57.33% $ 400 66.43% $ 400 70.36% $ 700 73.42% Multifamily residential .. 75 2.71 100 2.54 50 1.21 50 1.12 75 1.37 Construction ............. 150 4.66 150 4.82 55 5.80 50 3.78 100 4.83 Nonresidential ........... 225 7.20 225 8.33 70 3.74 50 3.53 225 4.13 Commercial business loans .. 1,254 9.39 744 8.06 500 11.83 500 11.85 273 9.67 Consumer loans ............. 618 19.74 1,117 18.92 491 10.99 487 9.36 136 6.58 -------- ------- -------- ------- -------- ------- -------- ------- -------- -------- Total allowance for loan losses .................... $ 3,022 100.00% $ 3,136 100.00% $ 1,566 100.00% $ 1,537 100.00% $ 1,509 100.00% ======== ======= ======== ======= ======== ======= ======== ======= ======== ======== September 30, 1998 September 30, 1997 ------------------ ------------------ Percent Percent of Loans of Loans in in Each Each Category Category to Total to Total Amount Loans Amount Loans -------- -------- -------- -------- Real estate loans: One- to four-family residential ............ $ 699 73.50% $ 643 76.50% Multifamily residential .. 75 2.63 100 4.68 Construction ............. 125 7.36 55 4.22 Nonresidential ........... 200 5.63 105 5.26 Commercial business loans .. 104 4.62 100 4.00 Consumer loans ............. 208 6.26 107 5.34 -------- ------- -------- -------- Total allowance for loan losses .................... $ 1,411 100.00% $ 1,110 100.00% ======== ======= ======== ========
51 Investment Activities We purchase investment securities with excess liquidity that arises when investable funds exceed loan demand. Our investment policies generally limit investments to U.S. Government and agency securities, municipal bonds, certificates of deposit, investment grade corporate debt obligations, mortgage-backed securities and certain types of mutual funds. Our investment policy does not permit engaging directly in hedging activities or purchasing high-risk mortgage derivative products or non-investment grade corporate bonds. Investments are made based on certain considerations, which include the interest rate, yield, settlement date and maturity of the investment, our liquidity position, and anticipated cash needs and sources (which in turn include outstanding commitments, upcoming maturities, estimated deposits and anticipated loan amortization and repayments). The effect that the proposed investment would have on our credit and interest rate risk and risk-based capital is also considered. The following table sets forth the amortized cost and fair value of our investment and mortgage-backed securities, at the dates indicated.
March 31, 2002 December 31, 2001 December 31, 2000 --------------------------------- -------------------------------- ---------------------------------- Net Net Net Unrealized Unrealized Unrealized Amortized Gain Amortized Gain Amortized Gain Cost (Loss) Fair Value Cost (Loss) Fair Value Cost (Loss) Fair Value --------- ---------- ---------- --------- --------- ---------- --------- ---------- ---------- (Dollars In Thousands) Investment Securities: U.S. Government and agency securities held to maturity ............. $ -- $ -- $ -- -- $ -- $ -- $ -- $ -- $ -- U.S. Government and agency securities available for sale ...... 10,854 224 11,078 11,902 202 12,104 22,204 (92) 22,112 Municipal bonds held to maturity ................ -- -- -- -- -- -- -- -- -- Municipal bonds available for sale ...... 6,202 (16) 6,186 6,205 (93) 6,112 6,216 (179) 6,037 Corporate bonds available for sale ...... 2,012 51 2,063 4,020 141 4,161 3,002 37 3,039 --------- --------- --------- --------- --------- --------- --------- --------- --------- Total investment securities ................ $ 19,068 $ 259 $ 19,327 $ 22,127 $ 250 $ 22,377 $ 31,422 $ (234) $ 31,188 ========= ========= ========= ========= ========= ========= ========= ========= ========= Mortgage-backed securities: FHLMC held to maturity ... -- -- -- $ -- $ -- $ -- $ -- $ -- $ -- FNMA held to maturity .... -- -- -- -- -- -- -- -- -- GNMA held to maturity .... -- -- -- -- -- -- -- -- -- FHLMC available for sale . 7,592 (36) 7,556 8,736 36 8,772 5,241 (44) 5,197 FNMA available for sale .. 3,735 -- 3,735 3,368 42 3,410 2,829 (37) 2,792 GNMA available for sale .. 9,734 3 9,737 11,042 97 11,139 11,230 (67) 11,163 SBA available for sale ... 1,998 (19) 1,979 2,103 (19) 2,084 3,905 (102) 3,803 --------- --------- --------- --------- --------- --------- --------- --------- --------- Total mortgage-backed securities ............... $ 23,059 $ (52) $ 23,007 $ 25,249 $ 156 25,405 $ 23,205 $ (250) $ 22,955 ========= ========= ========= ========= ========= ========= ========= ========= ========= Other Investments available for sale: FHLMC common stock ....... 19 1,198 1,217 19 1,259 1,278 19 1,303 1,322 Other equity securities .. 2,335 (20) 2,315 2,248 43 2,291 243 69 312 --------- --------- --------- --------- --------- --------- --------- --------- --------- Total other investments ... $ 2,354 $ 1,178 $ 3,532 $ 2,267 $ 1,302 $ 3,569 $ 262 $ 1,372 $ 1,634 ========= ========= ========= ========= ========= ========= ========= ========= =========
52
September 30, 2000 September 30, 1999 ----------------------------------- ----------------------------------- Net Net Unrealized Unrealized Amortized Gain Amortized Gain Cost (Loss) Fair Value Cost (Loss) Fair Value --------- ---------- ---------- --------- ---------- ---------- (Dollars In Thousands) Investment Securities: U.S. Government and agency securities held to maturity............................ $ 12,499 $ (577) $ 11,922 $ 12,498 $ (497) $ 12,001 U.S. Government and agency securities available for sale.......................... 13,274 (113) 13,161 9,256 (97) 9,159 Municipal bonds held to maturity............. 365 (2) 363 367 -- 367 Municipal bonds available for sale........... 5,854 (300) 5,554 5,737 (373) 5,364 Corporate bonds available for sale........... -- -- -- -- -- -- --------- --------- --------- --------- --------- --------- Total investment securities $ 31,992 $ (992) $ 31,000 $ 27,858 $ (967) $ 26,891 ========= ========== ========= ========= ========= ========= Mortgage-backed securities: FHLMC held to maturity....................... $ 1,146 $ (18) $ 1,128 $ 1,646 $ (13) $ 1,633 FNMA held to maturity........................ 971 (11) 960 1,416 (15) 1,401 GNMA held to maturity........................ 640 6 646 764 6 770 FHLMC available for sale..................... FNMA available for sale...................... 6,278 (159) 6,119 2,485 (72) 2,413 GNMA available for sale...................... 7,114 (237) 6,877 8,015 (233) 7,782 SBA available for sale....................... 4,119 (101) 4,018 6,043 (71) 5,972 --------- --------- --------- --------- --------- --------- Total mortgage-backed securities $ 20,268 $ (520) $ 19,748 $ 20,369 $ (398) $ 19,971 ========= ========= ========= ========= ========= ========= Other Investments available for sale: FHLMC common stock........................... $ 19 $ 1,019 $ 1,038 $ 25 $ 1,136 $ 1,161 Other equity securities...................... 243 69 312 93 -- 93 --------- --------- --------- --------- --------- --------- Total other investments....................... $ 262 $ 1,088 $ 1,350 $ 118 $ 1,136 $ 1,254 ========= ========= ========= ========= ========= =========
53 The following table sets forth information regarding the scheduled maturities, carrying values, approximate fair values, and weighted average yields for our investment securities portfolio at March 31, 2002 by contractual maturity. The following table does not take into consideration the effects of scheduled repayments or the effects of possible prepayments.
March 31, 2002 -------------------------------------------------------------------------------------------- Less than 1 year 1 to 5 years Over 5 to 10 years Over 10 years -------------------- --------------------- --------------------- -------------------- Weighted Weighted Weighted Weighted Average Average Average Average Book Value Yield Book Value Yield (1) Book Value Yield (1) Book Value Yield ---------- --------- ---------- --------- ---------- --------- ---------- -------- (Dollars in Thousands) U.S. Agency securities ........... $ 2,500 6.01% $ 1,896 6.32% $ 6,458 6.36% $ -- --% Municipal securities ............. 155 4.10 2,318 4.01 1,272 4.22 2,457 4.64 Corporate securities ............. -- -- 2,012 6.34 -- -- -- -- ---------- -------- --------- -------- --------- --------- --------- -------- Total ............................ $ 2,655 5.90% $ 6,226 5.46% $ 7,730 6.01% $ 2,457 4.64% ========== ======== ========= ======== ========= ========= ========= ======== -------------------------------- Total Securities -------------------------------- Weighted Average Market Book Value Yield Value ---------- --------- --------- U.S. Agency securities ........... $ 10,854 6.27% $ 11,078 Municipal securities ............. 6,202 4.30 6,186 Corporate securities ............. 2,012 6.34 2,063 ---------- -------- --------- Total ............................ $ 19,068 5.64% $ 19,327 ========== ======== =========
__________ (1) Yields on tax exempt obligations have been computed on a tax equivalent basis. 54 Deposit Activities and Other Sources of Funds General. Deposits are the major external source of funds for our lending and other investment activities. In addition, we also generate funds internally from loan principal repayments and prepayments and maturing investment securities. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and money market conditions. Borrowings from the Federal Home Loan Bank of Atlanta may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. Deposit Accounts. Our deposit products include a broad selection of deposit instruments, including checking accounts, money market accounts, savings accounts, individual retirement accounts, and term certificate accounts. We offer these products to both retail and commercial customers. Deposit account terms vary with the principal difference being the minimum balance deposit, early withdrawal penalties and the interest rate. We review our deposit mix and pricing weekly. We do not utilize brokered deposits, nor have we aggressively sought jumbo certificates of deposit. We believe we are competitive in the type of accounts and interest rates we offer on our deposit products. We do not seek to pay the highest deposit rates, but a competitive rate. We determine the rates paid based on a number of conditions, including rates paid by competitors, rates on U.S. Treasury securities, rates offered on alternative lending programs, and the deposit growth rate we are seeking to achieve. The following tables sets forth information concerning our time deposits and other interest-bearing deposits at the dates indicated.
March 31, 2002 December 31, 2001 December 31, 2000 September 30, 2000 September 30, 1999 ------------------ ------------------- ------------------- ------------------ ------------------ Average Average Average Average Average Interest Interest Interest Interest Interest Category Balance Rate Balance Rate Balance Rate Balance Rate Balance Rate - ---------------------------- --------- -------- --------- -------- --------- -------- --------- -------- --------- -------- (Dollars in Thousands) Noninterest bearing demand ................... $ 9,680 0.0% $ 7,953 0.0% $ 7,096 0.0% $ 5,272 0.0% $ 6,481 0.0% Interest bearing demand .... 25,497 0.4 25,330 1.2 14,562 1.7 14,009 1.1 11,916 1.6 Money market deposit ....... 30,946 1.5 29,489 2.7 14,690 3.5 14,909 3.2 13,709 2.1 Savings accounts ........... 46,385 1.5 44,011 2.1 17,923 3.0 19,189 3.1 23,869 3.2 Certificates of deposit .... 239,574 3.0 246,909 5.4 113,660 5.6 107,973 5.4 103,450 5.2 --------- ------- --------- ------- --------- ------- --------- ------- --------- ------- Total Deposits ............. $ 352,082 2.8% $ 353,692 4.2% $ 167,931 4.7% $ 161,352 4.3% $ 159,425 4.1% ========= -====== ========= ======= ========= ======= ========= ======= ========= =======
The following table indicates the amount of our certificate accounts with a principal balance greater than $100,000 by time remaining until maturity as of March 31, 2002. Maturity Period Certificates of Deposit - --------------- ----------------------- (In Thousands) Within three months ................................... $ 14,925 Three to six months ................................... 18,443 Six through twelve months ............................. 15,025 Over twelve months .................................... 4,390 ----------- Total jumbo certificates of deposit ................ $ 52,783 =========== Time Deposits by Rates. The following table sets forth the amount of time deposits in Citizens South Bank categorized by rates at the dates indicated.
March 31, December 31, September 30, ---------------------- ----------------------- 2002 2001 2000 2000 1999 ---------- ---------- ---------- ---------- ---------- (In Thousands) Interest Rate - ------------- 2.00-4.00% ..................... $ 150,243 $ 96,028 $ 145 $ 767 $ 759 4.01-6.00% ..................... 74,969 129,737 53,289 63,941 102,279 6.01-8.00% ..................... 14,362 21,144 60,226 43,265 412 ---------- ---------- ---------- ---------- ---------- $ 239,574 $ 246,909 $ 113,660 $ 107,973 $ 103,450 ========== ========== ========== ========== ==========
55 Time Deposits by Maturities. The following table sets forth the amount of time deposits in Citizens South Bank categorized by rates and maturities at March 31, 2002.
Maturity Date ----------------------------------------------------------------------------------- Interest Rate 1 Year or Less Over 1 to 2 Years Over 2 to 3 Years Over 3 Years Total - ------------- -------------- ----------------- ----------------- -------------- ------------- (In Thousands) 2.01-4.0% ........ $ 134,848 $ 11,116 $ 3,689 $ 590 $ 150,243 4.01-6.0% ........ 65,732 3,550 4,077 1,610 74,969 6.01-8.0% ........ 13,223 1,023 116 -- 14,362 ---------- ---------- ---------- ---------- ---------- Total ............ $ 213,803 $ 15,689 $ 7,882 $ 2,200 $ 239,574 ========== ========== ========== ========== ==========
Deposit Activity. The following table sets forth the deposit activity of Citizens South Bank for the periods indicated.
For the Three Months Ended March 31, For the Twelve Months Ended --------------------- --------------------------------------------------------------------- December December September September September September 2002 2001 31, 2001 31, 2000 30, 2000 30, 1999 30, 1998 30, 1997 --------- --------- --------- --------- --------- --------- --------- --------- (In Thousands) Beginning balance ........ $ 353,692 $ 167,931 $ 167,931 $ 158,603 $ 159,425 $ 143,901 $ 145,444 $ 145,975 Deposits acquired in acquisition ............ -- -- 175,350 -- -- -- -- -- Net increase (decrease) before interest credited ............... (4,270) 10,537 4,222 3,006 (4,748) 9,102 (8,215) (7,386) Interest credited ........ 2,660 1,938 6,189 6,322 6,675 6,422 6,672 6,855 --------- --------- --------- --------- --------- --------- --------- --------- Net increase (decrease) in savings deposits .... (1,610) 12,475 185,761 9,328 1,927 15,524 (1,543) (531) --------- --------- --------- --------- --------- --------- --------- --------- Ending balance ........... $ 352,082 $ 180,406 $ 353,692 $ 167,931 $ 161,352 $ 159,425 $ 143,901 $ 145,444 ========= ========= ========= ========= ========= ========= ========= =========
Borrowings. We also may use advances from the Federal Home Loan Bank of Atlanta to supplement our supply of lendable funds and to meet deposit withdrawal requirements. The Federal Home Loan Bank functions as a central reserve bank providing credit for member financial institutions. As a member of the Federal Home Loan Bank, we are required to own capital stock in the Federal Home Loan Bank and are authorized to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities that are obligations of, or guaranteed by, the U.S. Government) provided certain creditworthiness standards have been met. Advances are made pursuant to several different credit programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. The following table summarizes our borrowings from the Federal Home Loan Bank of Atlanta.
For the Twelve Months Ended For the Three -------------------------------------------------------- Months Ended December 31, December 31, September 30, September 30, March 31, 2002 2001 2000 2000 1999 -------------- ------------ ------------ ------------- ------------- (Dollars in Thousands) Advances from FHLB: Average balance outstanding ......... $ 39,900 $ 42,800 $ 40,900 $ 39,400 $ 28,700 Maximum amount outstanding at any month during the year .............. 40,500 42,500 42,500 43,500 35,500 Balance outstanding at end of year .. 39,000 40,500 42,500 40,000 35,500 Weighted average interest rate during year ........................ 5.68% 5.60% 5.83% 5.87% 5.20%
Subsidiary Activities Citizens South Financial Services, Inc., doing business as Citizens South Investment Services, a wholly owned subsidiary of Citizens South Bank, operates as an independent agent selling various non-deposit financial products, including mutual funds and annuities. Citizens South Investment Services also offers wealth management and financial planning services, and expects its offering of these services to increase in the future. 56 Personnel As of March 31, 2002, we had 89 full-time employees and 10 part-time employees. The employees are not represented by a collective bargaining unit and we consider our relationship with our employees to be good. Properties We conduct our business through nine full service banking offices. The following table sets forth information about such offices as well as the former operations center of Citizens Bank as of March 31, 2002.
Net Book Value of Property or Original Year Location Leasehold Improvements Leased or Owned Acquired or Built - -------- ---------------------- --------------- ----------------- 245 West Main Avenue Gastonia, North Carolina 28052-4140 $ 296,000 Owned 1971 1535 Burtonwood Drive Gastonia, North Carolina 28054-4011 164,000 Owned 1976 233 South Main Street Mount Holly, North Carolina 28120-1620 490,000 Owned 1990 1670 Neal Hawkins Road Gastonia, North Carolina 28056-6429 411,000 Owned 1987 3135 Dallas High Shoals Road Dallas, North Carolina 28034-1307 906,000 Owned 2000 412 South Highway 27 Stanley, North Carolina 28164-2055 1,098,000 Owned 2001 427 West Innes Street Salisbury, North Carolina 28144-4232 509,000 Owned 1825* 401 West Innes Street Salisbury, North Carolina 28144-4332 864,000 Owned 1961 106 West Main Street Rockwell, North Carolina 28138-8859 172,000 Owned 1963 307 North Center Street Statesville, North Carolina 28677-4063 1,025,000 Owned 1974 ------------ Total Net Book Value of Property or Leasehold Improvements $ 5,935,000 ============
The mailing address for all offices is P.O. Box 2249, Gastonia, North Carolina 28053-2249. * The former operations center of Citizens Bank. This office relocated to its present site and was renovated in 1974. Legal Proceedings We are involved periodically in various claims and lawsuits that arise in connection with our financial services business. We believe that these routine legal proceedings, in the aggregate, are not material to our financial condition and results of operations. SUPERVISION AND REGULATION General Citizens South Bank is examined and supervised by the Office of Thrift Supervision and the Federal Deposit Insurance Corporation. This regulation and supervision establishes a comprehensive framework of 57 activities in which an institution may engage and is intended primarily for the protection of the Federal Deposit Insurance Corporation's deposit insurance funds and depositors. Under this system of federal regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. Following completion of its examination, the federal agency critiques the institution's operations and assigns its rating (known as an institution's CAMELS). Under federal law, an institution may not disclose its CAMELS rating to the public. Citizens South Bank also is a member of and owns stock in the Federal Home Loan Bank of Atlanta, which is one of the twelve regional banks in the Federal Home Loan Bank System. Citizens South Bank also is regulated to a lesser extent by the Board of Governors of the Federal Reserve System, governing reserves to be maintained against deposits and other matters. The Office of Thrift Supervision examines Citizens South Bank and prepares reports for the consideration of its board of directors on any operating deficiencies. Citizens South Bank's relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters concerning the ownership of deposit accounts and the form and content of Citizens South Bank's loan documents. Any change in these laws or regulations, whether by the Federal Deposit Insurance Corporation, Office of Thrift Supervision or Congress, could have a material adverse impact on Citizens South Banking Corporation and Citizens South Bank and their operations. Federal Banking Regulation Business Activities. A federal savings bank derives its lending and investment powers from the Home Owners' Loan Act, as amended, and the regulations of the Office of Thrift Supervision. Under these laws and regulations, Citizens South Bank may invest in mortgage loans secured by residential and commercial real estate, commercial business and consumer loans, certain types of debt securities and certain other assets. Citizens South Bank also may establish subsidiaries that may engage in activities not otherwise permissible for Citizens South Bank, including real estate investment and securities and insurance brokerage. Capital Requirements. Office of Thrift Supervision regulations require savings banks to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for banks receiving the highest rating on the CAMELS rating system) and an 8% risk-based capital ratio. The prompt corrective action standards discussed below, in effect, establish a minimum 2% tangible capital standard. The risk-based capital standard for savings banks requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation based on the risks believed inherent in the type of asset. Core capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. At March 31, 2002, Citizens South Bank's capital exceeded all applicable requirements. Loans-to-One Borrower. A federal savings bank generally may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus on an unsecured basis. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, but generally does not include real estate. As of March 31, 2002, Citizens South Bank was in compliance with the loans-to-one borrower limitations. Qualified Thrift Lender Test. As a federal savings bank, Citizens South Bank is subject to a qualified thrift lender, or "QTL," test. Under the QTL test, Citizens South Bank must maintain at least 65% of its "portfolio assets" 58 in "qualified thrift investments" in at least nine months of the most recent 12 month period. "Portfolio assets" generally means total assets of a savings institution, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings bank's business. "Qualified thrift investments" includes various types of loans made for residential and housing purposes, investments related to such purposes, including certain mortgage-backed and related securities, and loans for personal, family, household and certain other purposes up to a limit of 20% of portfolio assets. "Qualified thrift investments" also include 100% of an institution's credit card loans, education loans and small business loans. Citizens South Bank also may satisfy the QTL test by qualifying as a "domestic building and loan association" as defined in the Internal Revenue Code of 1986. A savings bank that fails the qualified thrift lender test must either convert to a bank charter or operate under specified restrictions. At March 31, 2002, Citizens South Bank maintained approximately 75.8% of its portfolio assets in qualified thrift investments. Capital Distributions. Office of Thrift Supervision regulations govern capital distributions by a federal savings bank, which include cash dividends, stock repurchases and other transactions charged to the capital account. A savings bank must file an application for approval of a capital distribution if: . the total capital distributions for the applicable calendar year exceed the sum of the savings bank's net income for that year to date plus the savings bank's retained net income for the preceding two years; . the bank would not be at least adequately capitalized following the distribution; . the distribution would violate any applicable statute, regulation, agreement or Office of Thrift Supervision-imposed condition; or . the savings bank is not eligible for expedited treatment of its filings. Even if an application is not otherwise required, every savings bank that is a subsidiary of a holding company must still file a notice with the Office of Thrift Supervision at least 30 days before the board of directors declares a dividend or approves a capital distribution. The Office of Thrift Supervision may disapprove a notice or application if: . the savings bank would be undercapitalized following the distribution; . the proposed capital distribution raises safety and soundness concerns; or . the capital distribution would violate a prohibition contained in any statute, regulation or agreement. Liquidity. A federal savings bank is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation. Community Reinvestment Act and Fair Lending Laws. All savings banks have a responsibility under the Community Reinvestment Act and related regulations of the Office of Thrift Supervision to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In connection with its examination of a federal savings bank, the Office of Thrift Supervision is required to assess the savings bank's record of compliance with the Community Reinvestment Act. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. A bank's failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the Office of Thrift Supervision, as well as other federal regulatory agencies and the Department of Justice. Citizens South Bank received a "satisfactory" Community Reinvestment Act rating in its most recent federal examination. 59 Transactions with Related Parties. A federal savings bank's authority to engage in transactions with its "affiliates" is limited by Office of Thrift Supervision regulations and by Sections 23A and 23B of the Federal Reserve Act (the "FRA"). The term "affiliates" for these purposes generally means any company that controls or is under common control with an institution. Citizens South Banking Corporation and its non-savings institution subsidiaries are affiliates of Citizens South Bank. In general, transactions with affiliates must be on terms that are as favorable to the savings bank as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of the savings bank's capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the savings bank. In addition, Office of Thrift Supervision regulations prohibit a savings bank from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary. Citizens South Bank's authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features, and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Citizens South Bank's capital. In addition, extensions of credit in excess of certain limits must be approved by Citizens South Bank's board of directors. Enforcement. The Office of Thrift Supervision has primary enforcement responsibility over federal savings institutions and has the authority to bring enforcement action against all "institution-affiliated parties," including stockholders, and attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institution, receivership, conservatorship or the termination of deposit insurance. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The Federal Deposit Insurance Corporation also has the authority to recommend to the Director of the Office of Thrift Supervision that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take action under specified circumstances. Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation, and other operational and managerial standards as the agency deems appropriate. The federal banking agencies adopted Interagency Guidelines Prescribing Standards for Safety and Soundness to implement the safety and soundness standards required under federal law. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, internal audit systems, credit underwriting, loan documentation, interest rate risk exposure, asset growth, compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to submit a compliance plan. Prompt Corrective Action Regulations. Under the prompt corrective action regulations, the Office of Thrift Supervision is required and authorized to take supervisory actions against undercapitalized savings banks. For this purpose, a savings bank is placed in one of the following five categories based on the bank's capital: . well-capitalized (at least 5% leverage capital, 6% tier 1 risk-based capital and 10% total risk-based capital); 60 . adequately capitalized (at least 4% leverage capital, 4% tier 1 risk-based capital and 8% total risk-based capital); . undercapitalized (less than 8% total risk-based capital, 4% tier 1 risk-based capital or 3% leverage capital); . significantly undercapitalized (less than 6% total risk-based capital, 3% tier 1 risk-based capital or 3% leverage capital); and . critically undercapitalized (less than 2% tangible capital). Generally, the banking regulator is required to appoint a receiver or conservator for a bank that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the date a bank receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to the bank, including, but not limited to, restrictions on growth, investment activities, capital distributions and affiliate transactions. The Office of Thrift Supervision may also take any one of a number of discretionary supervisory actions against undercapitalized banks, including the issuance of a capital directive and the replacement of senior executive officers and directors. At March 31, 2002, Citizens South Bank met the criteria for being considered "well-capitalized." Insurance of Deposit Accounts. Deposit accounts in Citizens South Bank are insured by the Savings Association Insurance Fund of the Federal Deposit Insurance Corporation, generally up to a maximum of $100,000 per separately insured depositor. Citizens South Bank's deposits therefore are subject to Federal Deposit Insurance Corporation deposit insurance assessments. The Federal Deposit Insurance Corporation has adopted a risk-based system for determining deposit insurance assessments. The Federal Deposit Insurance Corporation is authorized to raise the assessment rates as necessary to maintain the required ratio of reserves to insured deposits of 1.25%. In addition, all Federal Deposit Insurance Corporation-insured institutions must pay assessments to the Federal Deposit Insurance Corporation at an annual rate of approximately .0212% of insured deposits to fund interest payments on bonds maturing in 2017 issued by a federal agency to recapitalize the predecessor to the Savings Association Insurance Fund. Prohibitions Against Tying Arrangements. Federal savings banks are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution. Federal Home Loan Bank System. Citizens South Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions. As a member of the Federal Home Loan Bank of Atlanta, Citizens South Bank is required to acquire and hold shares of capital stock in the Federal Home Loan Bank in an amount at least equal to 1% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its borrowings from the Federal Home Loan Bank, whichever is greater. As of March 31, 2002, Citizens South Bank was in compliance with this requirement. Federal Reserve System The Federal Reserve Board regulations require savings banks to maintain non-interest-earning reserves against their transaction accounts, such as negotiable order of withdrawal and regular checking accounts. At March 31, 2002, Citizens South Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements imposed by the Office of Thrift Supervision. 61 Holding Company Regulation Upon completion of the conversion, Citizens South Banking Corporation will be a unitary savings and loan holding company, subject to regulation and supervision by the Office of Thrift Supervision. The Office of Thrift Supervision has enforcement authority over Citizens South Banking Corporation and its non-savings institution subsidiaries. Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a risk to Citizens South Bank. Under prior law, a unitary savings and loan holding company generally had no regulatory restrictions on the types of business activities in which it may engage, provided that its subsidiary savings bank was a qualified thrift lender. The Gramm-Leach-Bliley Act of 1999, however, restricts unitary savings and loan holding companies not existing or applied for before May 4, 1999 to those activities permissible for financial holding companies or for multiple savings and loan holding companies. Citizens South Banking Corporation will not be a grandfathered unitary savings and loan holding company and, therefore, will be limited to the activities permissible for financial holding companies or for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance, incidental to financial activities or complementary to a financial activity. A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Office of Thrift Supervision, and certain additional activities authorized by Office of Thrift Supervision regulations. Federal law prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring control of another savings institution or holding company thereof, without prior written approval of the Office of Thrift Supervision. It also prohibits the acquisition or retention of, with specified exceptions, more than 5% of the equity securities of a company engaged in activities that are not closely related to banking or financial in nature or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision must consider the financial and managerial resources, future prospects of the savings institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors. Federal Securities Laws Citizens South Banking Corporation has filed with the Securities and Exchange Commission a registration statement under the Securities Act of 1933 for the registration of the common stock to be issued pursuant to the conversion. Upon completion of the conversion, Citizens South Banking Corporation common stock will continue to be registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934. Citizens South Banking Corporation will continue to be subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934. The registration under the Securities Act of 1933 of shares of common stock to be issued in the conversion does not cover the resale of those shares. Shares of common stock purchased by persons who are not affiliates of Citizens South Banking Corporation may be resold without registration. Shares purchased by an affiliate of Citizens South Banking Corporation will be subject to the resale restrictions of Rule 144 under the Securities Act of 1933. If Citizens South Banking Corporation meets the current public information requirements of Rule 144 under the Securities Act of 1933, each affiliate of Citizens South Banking Corporation that complies with the other conditions of Rule 144, including those that require the affiliate's sale to be aggregated with those of other persons, would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of 1% of the outstanding shares of Citizens South Banking Corporation, or the average weekly volume of trading in the shares during the preceding four calendar weeks. In the future, Citizens South Banking Corporation may permit affiliates to have their shares registered for sale under the Securities Act of 1933. 62 TAXATION Federal Taxation General. Citizens South Banking Corporation and Citizens South Bank are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to Citizens South Banking Corporation and Citizens South Bank. Method of Accounting. For federal income tax purposes, Citizens South Bank currently reports its income and expenses on the accrual method of accounting and uses a tax year ending December 31 for filing its consolidated federal income tax returns. The Small Business Protection Act of 1996 eliminated the use of the reserve method of accounting for bad debt reserves by savings institutions, effective for taxable years beginning after 1995. Bad Debt Reserves. Prior to the Small Business Protection Act of 1996, Citizens South Bank was permitted to establish a reserve for bad debts and to make annual additions to the reserve. These additions could, within specified formula limits, be deducted in arriving at Citizens South Bank's taxable income. As a result of the Act, Citizens South Bank must use the specific charge off method in computing its bad debt deduction beginning with its 1996 federal tax return. In addition, the federal legislation requires the recapture (over a six year period) of the excess of tax bad debt reserves at September 30, 1996 over those established as of September 30, 1988. The amount of such reserve subject to recapture as of March 31, 2002, was approximately $118,000. Taxable Distributions and Recapture. Prior to the Small Business Protection Act of 1996, bad debt reserves created prior to January 1, 1988 were subject to recapture into taxable income should Citizens South Bank fail to meet certain thrift asset and definitional tests. New federal legislation eliminated these thrift related recapture rules. However, under current law, pre-1988 reserves remain subject to recapture should Citizens South Bank make certain nondividend distributions or cease to maintain a bank charter. At March 31, 2002, Citizens South Bank's total federal pre-1988 reserve was approximately $8.0 million. This reserve reflects the cumulative effects of federal tax deductions by Citizens South Bank for which no federal income tax provision has been made. 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"). The AMT is payable to the extent such AMTI is in excess of an exemption amount. 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. Citizens South Bank has not been subject to the alternative minimum tax and has no such amounts available as credits for carryover. Net Operating Loss Carryovers. A financial institution may carry back net operating losses to the preceding five taxable years (for losses incurred in 2001 and 2002) and forward to the succeeding 20 taxable years. This provision applies to losses incurred in taxable years beginning after 1986. At March 31, 2002, Citizens South Bank had no net operating loss carryforwards for federal income tax purposes. Corporate Dividends-Received Deduction. Citizens South Banking Corporation may exclude from its income 100% of dividends received from Citizens South Bank as a member of the same affiliated group of corporations. Citizens South Holdings, MHC owns less than 80% of the outstanding common stock of Citizens South Banking Corporation. As such, Citizens South Holdings, MHC is not permitted to file a consolidated federal income tax return with Citizens South Banking Corporation and Citizens South Bank. 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 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. 63 State Taxation State of North Carolina. Under North Carolina law, the corporate income tax is 6.9% of federal taxable income as computed under the Internal Revenue Code, subject to certain prescribed adjustments. An annual state franchise tax is imposed at a rate of 0.15% applied to the greatest of the institution's (i) capital stock, surplus and undivided profits, (ii) investment in tangible property in North Carolina or (iii) 55% of the appraised valuation of property in North Carolina. MANAGEMENT OF CITIZENS SOUTH BANKING CORPORATION Directors The Board of Directors of Citizens South Banking Corporation currently consists of eight members. Approximately one-third of the directors are elected annually. Directors are generally elected to serve for three-year periods. The table below sets forth certain information regarding the composition of the Board of Directors of Citizens South Banking Corporation as of August __, 2002 including the terms of office of Board members.
Names Age Positions Held Director Since (1) Current Term to Expire ----- --- -------------- ----------------- ---------------------- Martha B. Beal 71 Director 1993 2005 Ronald E. Bostian 64 Executive Vice 2002 2004 President and Director James J. Fuller 59 Director 1972 2005 Charles D. Massey 65 Director 1971 2005 Senator David W. Hoyle 63 Chairman 1975 2003 Ben R. Rudisill, II 58 Vice Chairman 1977 2003 Eugene R. Matthews, II 45 Director 1998 2004 Kim S. Price 46 President, Chief 1997 2004 Executive Officer and Director
________________________________ (1) Reflects initial appointment to the Board of Directors of Citizens South Bank and its predecessors. The principal occupation during the past five years of each director and executive officer of Citizens South Banking Corporation is set forth below. All directors and executive officers have held their present positions for five years unless otherwise stated. Directors Martha B. Beal was the Vice President, Secretary, Treasurer, and Financial Officer of Chelsea House, Inc., a manufacturer of decorative arts, accessories, and furniture, from 1973 until her retirement in 1998. Ronald E. Bostian is an Executive Vice President and Director of Citizens South Bank and has served in those positions since Citizens South Banking Corporation acquired Innes Street Financial Corporation and its wholly owned subsidiary Citizens Bank, Inc., for which Mr. Bostian served as President and Chief Executive Officer from July 1, 1990 to December 31, 2001. James J. Fuller is the President of Mount Holly Furniture Company, Inc., and has served in that position since 1972. Charles D. Massey is the Managing Partner of Massey Properties, a real estate investment firm, and has served in that position since 1975. From 1957 to 2000, Mr. Massey also served in various positions with The Massey Company, Inc., a wholesale industrial distributor, from which he retired in December 2000 as Director of Information Services. Senator David W. Hoyle is a North Carolina State Senator and has served in that position since 1993. Prior to that, Senator Hoyle was a self-employed real estate developer and investor. 64 Ben R. Rudisill, II is the President of Rudisill Enterprises, Inc., a wholesale beverage distributor, and has served in that position since 1976. Eugene R. Matthews, II is the Vice President and Regional Director of Stores of Belk, Inc., a department store chain, and has served in that position since 1998. From 1980 to 1998, Mr. Matthews served as Senior Vice President of Matthews-Belk Co., Inc., a department store chain. Kim S. Price is the President and Chief Executive Officer of Citizens South Bank and has served in that position since August 1997. From 1991 to 1997, Mr. Price served as Vice President for Loan Production and in various other executive positions for First National Bank of Shelby. Executive Officers Who are Not Directors Gary F. Hoskins has served as Senior Vice President, Treasurer, and Chief Financial Officer of Citizens South Bank since August 1997. Prior to that Mr. Hoskins served as a Senior Vice President, Secretary, Treasurer, and Chief Financial Officer of Cherryville Federal Savings and Loan Association from 1995 to 1997. Paul L. Teem, Jr. has served as Executive Vice President and Secretary of Citizens South Bank since 1983, and Chief Administrative Officer since November 2000. Michael R. Maguire has served as Senior Vice President and Chief Credit Officer of Citizens South Bank since May 1999. Prior to that Mr. Maguire served as a Vice President and in various executive capacities in the commercial banking functions of First Union National Bank of North Carolina from 1984 to May 1999. Vance B. Brinson, Jr. has served as Executive Vice President and Chief Lending Officer of Citizens South Bank since March 2002. Prior to that Mr. Brinson served as a Senior Vice President and in various executive capacities in the commercial banking functions of Wachovia Bank, N.A., from 1977 to March 2002. Meetings and Committees of the Board of Directors General. The business of Citizens South Banking Corporation is conducted at regular and special meetings of the full Board and its standing committees. The standing committees consist of the Executive and Audit Committees. The full Board of Directors acts as Nominating Committee for Citizens South Banking Corporation. During the fiscal year ended December 31, 2001, the Board of Directors of Citizens South Banking Corporation met at 14 regular meetings. No member of the Board or any committee thereof attended less than 75% of said meetings. Executive Committee. The Executive Committee consists of Directors Hoyle (who serves as Chairman), Rudisill, Matthews, and Price. The Executive Committee meets as necessary when the Board is not in session to exercise general control and supervision in all matters pertaining to the interests of Citizens South Banking Corporation, subject at all times to the direction of the Board of Directors. The Executive Committee met 15 times during the fiscal year ended December 31, 2001. Audit Committee. The Audit Committee consists of Directors Massey (who serves as Chairman), Rudisill and Beal. Each member of the Audit Committee is "independent" as defined in the listing standards of the National Association of Securities Dealers. The Audit Committee examines and approves the audit report prepared by the independent auditors of Citizens South Bank, reviews and recommends the independent auditors to be engaged by Citizens South Banking Corporation, reviews the internal accounting controls of Citizens South Banking Corporation, and reviews and approves internal audit policies and procedures. The Company's Board of Directors has adopted a written charter for the Audit Committee. The Audit Committee met four times during the fiscal year ended December 31, 2001. Employment Agreements Citizens South Bank has entered into an employment agreement with its President and Chief Executive Officer, Kim S. Price, which provides for a term of 36 months. On each anniversary date, the agreement may be 65 extended for an additional 12 months, so that the remaining term shall be 36 months. If the agreement is not renewed, the agreement will expire 36 months following the anniversary date. At January 1, 2002, the base salary for Mr. Price was $150,000. The base salary may be increased but not decreased. In addition to the base salary, the agreement provides for, among other things, participation in stock benefit plans and other employee and fringe benefits applicable to executive personnel. The agreement provides for termination by Citizens South Bank for cause at any time. In the event Citizens South Bank terminates the executive's employment for reasons other than for cause, or in the event of the executive's resignation from Citizens South Bank upon (i) failure to re-elect the executive to his current offices, (ii) a material change in the executive's functions, duties or responsibilities, or relocation of his principal place of employment by more than 30 miles, (iii) liquidation or dissolution of Citizens South Bank, or (iv) a breach of the agreement by Citizens South Bank, the executive, or in the event of death, his beneficiary, would be entitled to severance pay in an amount equal to three times the annual rate of Base Salary (which includes any salary deferred at the election of Mr. Price) at the time of termination, plus the highest annual cash bonus paid to him during the prior three years. Citizens South Bank would also continue the executive's life, health, dental and disability coverage for the remaining unexpired term of the agreement. The executive's employment may be terminated upon his attainment of normal retirement age (i.e., age 65) or in accordance with any retirement policy established by Citizens South Bank (with Mr. Price's consent with respect to him). Upon Mr. Price's retirement, he will be entitled to all benefits available to him under any retirement or other benefit plan maintained by Citizens South Bank. In the event of the executive's disability for a period of six months, Citizens South Bank may terminate the agreement provided that Citizens South Bank will be obligated to pay the executive his Base Salary for the remaining term of the agreement or one year, whichever is longer, reduced by any benefits paid to the executive pursuant to any disability insurance policy or similar arrangement maintained by Citizens South Bank. In the event of the executive's death, Citizens South Bank will pay his Base Salary to his named beneficiaries for one year following his death, and will also continue medical, dental, and other benefits to his family for one year. The employment agreement provides that, following termination of employment, the executive will not compete with Citizens South Bank for a period of one year, provided, however, that in the event of a termination in connection with a change in control within the meaning of Home Owners' Loan Act, as amended, and the rules and regulations thereunder, the noncompete provisions will not apply. Citizens South Bank has also entered into an employment agreement with Ronald E. Bostian, Executive Vice President, which provides for a term of 24 months. Within 30 days prior to the first anniversary date of the agreement, the Board will conduct a performance evaluation of the executive and based on the result of the evaluation, may terminate the executive's employment in accordance with the terms of the agreement. At January 1, 2002, the base salary for Mr. Bostian was $150,000. In addition to the base salary, the agreement provides for, among other things, participation in benefits provided uniformly to permanent full-time employees of Citizens South Bank. The agreement provides for termination by Citizens South Bank for cause at any time. In the event of the executive's disability for a period of six months, Citizens South Bank may terminate the agreement, provided that Citizens South Bank will be obligated to pay the executive his base salary for the remaining term of the agreement, reduced by any benefits paid to the executive pursuant to any disability insurance policy or similar arrangement maintained by Citizens South Bank. In the event Citizens South Bank terminates the executive's employment for reasons other than for cause or disability, or in the event of the executive's resignation from Citizens South Bank upon (i) failure to re-elect the executive to his executive position, (ii) a relocation of his principal place of employment by more than 50 miles, (iii) liquidation or dissolution of Citizens South Bank or Citizens South Banking Corporation, or (iv) a breach of the agreement by Citizens South Bank, the executive, or in the event of death, his beneficiary, would be entitled to severance pay in an amount equal to the pro-rated Base Salary for the remaining term of the agreement. Citizens South Bank would also continue the executive's life, medical and dental coverage for the remaining term of the agreement. In the event the payments to the executive would include an "excess parachute payment" as defined by Internal Revenue Code of 1986, as amended, Section 280G (relating to payments made in connection with a change in control), the payments would be reduced in order to avoid having an excess parachute payment. The employment agreement provides that, following termination of employment, the executive will not compete with Citizens South Bank for a period of one year, provided, however, that in the event of a termination in connection with a change in control within the meaning of Home Owners' Loan Act, as amended, and the rules and regulations thereunder, the noncompete provisions will not apply. 66 Executive Supplemental Retirement Plan. In June 2001, Citizens South Bank adopted an Executive Supplemental Retirement Plan for six executives, including Messrs. Price, Teem and Maguire. The Executive Supplemental Retirement Plan is a non-qualified, unfunded deferred compensation plan evidenced by separate agreements for each executive. Although the Executive Supplemental Retirement Plan is unfunded, Citizens South Bank has purchased life insurance policies on each executive that are actuarially designed to offset the annual expenses associated with the plan and will, if the actuarial assumptions are accurate, offset all of the costs associated with the plan during the life of the executive, providing complete recovery of all plan costs upon the executive's death. The amount of an executive's benefit will be determined pursuant to the accrual of two accounts: (i) a pre-retirement account and (ii) an index retirement benefit account. The pre-retirement account is a liability reserve account of Citizens South Bank and is increased or decreased each year by the aggregate annual after-tax income from specified life insurance contracts reduced by an "opportunity cost," which is calculated by taking into account Citizens South Bank's after-tax cost of funds. The index retirement benefit account is equal to the excess of the annual earnings of the insurance policies over the "opportunity cost." Upon retirement at age 65 (normal retirement) or prior to the normal retirement age, provided the executive has attained age 55 (early retirement), the balance in the executive's pre-retirement account will be paid in 156 monthly installments commencing within 30 days following the executive's retirement. In addition, upon normal or early retirement, the executive will receive an index retirement benefit annually until his death. Should the executive die prior to having received the entire amount of his pre-retirement account, the unpaid balance will be paid in a lump sum to his designated beneficiaries; however, no death benefit shall be payable under the Executive Supplemental Retirement Plan if the executive dies before March 20, 2003. Messrs. Price and Teem vest in their benefits under the plan at the rate of 20% per year of employment with Citizens South Bank. At the end of 2001, Mr. Teem was 100% vested in his accrued benefit and Mr. Price was 80% vested. Mr. Maguire will vest in his benefits under the plan at the rate of 10% per year times the number of years from the effective date of the executive agreement, to a maximum of 75%, prior to attaining age 60. Upon attainment of age 60, Mr. Maguire's vested percentage in his accounts will be 75%, and will increase by 5% for each subsequent year, until full vesting at age 65. In the event Mr. Price, Teem or Maguire becomes disabled prior to termination of employment and the executive's employment is terminated because of such disability, the executive will be entitled to receive the balance in his pre-retirement account payable in 156 monthly installments commencing 30 days following termination of service due to disability. In addition, the executive will receive the annual index retirement benefit until the executive's death. The benefits under the Executive Supplemental Retirement Plan are forfeitable by the executive if the executive's service is terminated by Citizens South Bank for cause. In the event of a change in control, the executive will be entitled to the benefits due upon attainment of early retirement, as if the executive had been continuously employed by Citizens South Bank until his early retirement date. At December 31, 2001, Messrs. Price, Teem and Maguire had $18,696, $14,159, and $4,389, respectively, accrued to their pre-retirement accounts. Split Dollar Death Benefits. In conjunction with the adoption of the Executive Supplemental Retirement Plan, Citizens South Bank also adopted Endorsement Split Dollar Agreements with the six executives covered by the Executive Supplemental Retirement Plan. Under the Endorsement Split Dollar Agreements, if the executives die while employed by Citizens South Bank, their beneficiaries will be paid a death benefit equal to the net-at-risk insurance portion of the proceeds on certain life insurance policies purchased by Citizens South Bank on the executives' lives. If an executive dies after termination of employment with Citizens South Bank, the executive's beneficiary would receive a portion of the net-at-risk insurance proceeds equal to the amount of the net-at-risk insurance proceeds multiplied by the executive's vested percentage. Messrs. Price and Teem vest in their death benefits under the plan at the rate of 20% per year of employment with Citizens South Bank. At the end of 2001, Mr. Teem was 100% vested in his accrued benefit and Mr. Price was 80% vested. Mr. Maguire will vest in his benefits under the plan at the rate of 10% per year times the number of years from the effective date of the executive agreement, to a maximum of 75%, prior to attaining age 60. Upon attainment of age 60, Mr. Maguire's vested percentage in his accounts will be 75%, and will increase by 5% for each subsequent year, until full vesting at age 65. The net-at-risk insurance portion is the total proceeds less the cash value of the policy. 67 Merger/Acquisition Protection Agreements Citizens South Bank has entered into a merger/acquisition protection agreement with each of Michael R. Maguire, its Senior Vice President and Chief Credit Officer, Paul L. Teem, Jr., its Executive Vice President and Gary F. Hoskins, its Chief Financial Officer, pursuant to which each executive will be paid as severance a sum equal to one and one-half times his annual base salary in the event of a change in control of Citizens South Bank or Citizens South Banking Corporation. In exchange for this protection, the executive has agreed not to directly or indirectly compete against Citizens South Bank or Citizens South Banking Corporation for twelve months following the payment of the severance amount. The term of the agreement continues during the term of his employment and for twelve months following a change in control of Citizens South Bank or Citizens South Banking Corporation. Compensation of Directors Fees. During the fiscal year ended December 31, 2001 nonemployee Directors of Citizens South Bank (except for Mr. Bostian) received a retainer fee of $12,000 ($15,600 for the Chairman), plus a fee of $300 per Board meeting attended, $400 per meeting for attendance at Executive Committee meetings and $300 per meeting for all other committee meetings. Beginning January 1, 2002, this fee schedule applies to all directors except for the President and Chief Executive Officer. Deferred Compensation and Income Continuation Agreement. In May 1986, Citizens South Bank entered into nonqualified deferred compensation agreements ("DCA") for the benefit of certain Directors at that time, including Directors Hoyle, Rudisill, Fuller, and Massey. The DCAs provide each director with the opportunity to defer up to $20,000 of their usual compensation into the DCA. In the event of a director's termination of employment, amounts credited to his account under the DCA will be paid to him in 120 equal monthly installments beginning not later than the sixth month following the end of Citizens South Bank's year in which the director reaches age 70. In the event of death, amounts under the DCA will be paid to the director's designated beneficiaries. The DCA is an unfunded plan for tax purposes and for purposes of ERISA. All obligations arising under the DCA are payable from the general assets of Citizens South Bank. Citizens South Bank paid $24,624 during the fiscal year ended December 31, 2001 pursuant to the DCAs. Supplemental Executive Retirement Plan. In February 1992, Citizens South Bank entered into nonqualified supplemental retirement agreements ("SRA") for certain Directors at that time, including Directors Massey, Hoyle, Fuller, and Rudisill. Citizens South Bank entered into SRAs for Directors Beal and Matthews in October 2000. The SRAs provide for an annual benefit that ranges from $4,000 to $15,600. Monthly benefits are provided for designated beneficiaries of directors who die before or after age 70. Amounts not paid to the director, beneficiaries or spouse are paid to the estate of the director in a lump sum. Benefits under the SRA are forfeited if the director's service is terminated for cause. The SRA is considered an unfunded plan for tax and ERISA purposes. All obligations arising under the SRA are payable from the general assets of Citizens South Bank. During the fiscal year ended December 31, 2001, Citizens South Bank paid a total of $39,423 pursuant to the SRAs. Stock Benefit Plans. During the fiscal year ended September 30, 1999, Citizens South Bank adopted, and Citizens South Banking Corporation's stockholders approved, the Citizens South Bank 1999 Stock Option Plan. Pursuant to the Stock Option Plan, options to purchase 7,000 shares were granted to all non-employee directors at that time, including Directors Hoyle, Rudisill, Beal, Fuller, Massey and Matthews, at an exercise price of $12.00 per share, the fair market value of the underlying shares on the date of the award. The term of the options is ten years from the date of grant, and the shares subject to awards will be adjusted in the event of any merger, consolidation, reorganization, recapitalization, stock dividend, stock split, combination or exchange of shares or other change in the corporate structure of Citizens South Banking Corporation. The awards included an equal number of reload options, limited stock appreciation rights and dividend equivalent rights. A limited right gives the option holder the right, upon a change in control of Citizens South Banking Corporation or Citizens South Bank, to receive the excess of the market value of the shares represented by the limited rights on the date exercised over the exercise price. The limited rights are subject to the same terms and conditions as the stock options. Payment upon exercise of a limited right will be in cash. The dividend equivalent rights entitle the option holder to receive an amount of cash at the time that certain extraordinary dividends are declared equal to the amount of the extraordinary dividend multiplied by the number of options that the person holds. For these purposes, an extraordinary dividend is defined as any dividend where the rate of dividend exceeds Citizens South Bank's weighted average cost of funds on interest 68 bearing liabilities for the current and preceding three quarters. The reload options entitle the option holder, who has delivered shares that he or she owns as payment of the exercise price for option stock, to a new option to acquire additional shares equal in amount to the shares he or she has traded in. Reload options may also be granted to replace option shares retained by the employer for payment of the option holder's withholding tax. The option price at which additional shares of stock can be purchased by the option holder through the exercise of a reload option is equal to the market value of the previously owned stock at the time it was surrendered. The option period during which the reload option may be exercised expires at the same time as that of the original option that the holder has exercised. Executive Compensation The following table sets forth certain information as to the total remuneration paid to executive officers of Citizens South Banking Corporation who earned over $100,000 in salary and bonuses during fiscal 2001.
Annual Compensation Long-Term Compensation -------------------------------- ----------------------------------------------------------------- Awards Payouts --------------------------- ------------------------------------ Year Other Annual Restricted All Other Name and Ended Compensation Stock Options/ LTIP Compensation Principal Position 12/31 (1) Salary (2) Bonus (3) (4) Awards SARS(#) Payouts (5) - -------------------------- --------- ---------- --------- ------------ ------------ -------- ------- -------------- Kim S. Price 2001 $ 139,368 $ 34,000 -- -- -- -- $ 39,597 (10) President, Chief Executive 2000 $ 130,008 $ 25,000 -- -- -- -- $ 13,321 Officer, and Director 1999 $ 120,000 $ 25,000 -- $120,000 (6) 32,699 (7) -- $ 7,581 Paul L. Teem, Jr. 2001 $ 90,192 $ 15,000 -- -- -- -- $ 28,755 (10) Executive Vice President, 2000 $ 87,384 $ 12,000 -- -- -- -- $ 10,565 Secretary, and Chief 1999 $ 80,016 $ 10,000 -- $ 78,000 (8) 15,208 (7) -- $ 14,689 Administrative Officer Michael R. Maguire 2001 $ 88,032 $ 15,500 -- -- -- -- $ 12,842 Senior Vice President and 2000 $ 85,296 $ 10,000 -- -- -- -- $ 9,427 Chief Credit Officer 1999 $ 54,672 $ 3,500 -- -- 10,000 (9) -- $ 820
___________________________ (1) Compensation for the years 1999 and 2000 reflects a fiscal year ending on September 30. In 2001, Citizens South Banking Corporation changed the end of its fiscal year to December 31. (2) Includes compensation deferred at the election of executives pursuant to the 401(k) Plan of Citizens South Bank. (3) Includes bonuses deferred at the election of executives pursuant to the 401(k) Plan of Citizens South Bank. (4) Citizens South Bank provides certain members of senior management with certain other personal benefits, the aggregate value of which did not exceed the lesser of $50,000 or 10% of the total annual salary and bonus reported for each officer. The value of such benefits is not included in this table. (5) Includes employer contributions to Citizens South Bank's 401(k) Plan and Employee Stock Ownership Plan on behalf of the Executive. (6) Includes 10,000 shares of common stock awarded pursuant to the Recognition and Retention Plan, which shares vested on April 19, 1999. The value is based on the last sale price of the common stock on the day prior to the award. (7) Includes options awarded pursuant to the Stock Option Plan, which options vest in five equal annual installments commencing on April 19, 1999. The award included an equal number of reload options, limited rights and dividend equivalent rights, the terms of which are described in "--Compensation of Directors--Stock Benefit Plans" and "Stock Option Plan." (8) Includes 6,500 shares of common stock awarded pursuant to the Recognition and Retention Plan, which shares vested on April 19, 1999. The value is based on the last sale price of the common stock on the day prior to the award. (9) Includes options awarded pursuant to the Stock Option Plan, which options vest in five equal annual installments commencing on May 24, 2000. The award included an equal number of reload options, limited rights and dividend equivalent rights, the terms of which are described in "--Compensation of Directors--Stock Benefit Plans" and "Stock Option Plan." (10) Includes the vested portion of the annual increase in the value of Citizens South Bank's 2001 Executive Supplemental Retirement Plan. 69 Stock Option Plan The Board of Directors of Citizens South Banking Corporation has established a stock option plan which provides discretionary awards to its officers and key employees. The grant of awards to employees under the stock option plan was determined by the Board of Directors. No options were granted during the year ended December 31, 2001 to the Named Executive Officers. Set forth below is certain information concerning options outstanding to the Named Executive Officers at December 31, 2001, and the options exercised by the Named Executive Officers during 2001.
==================================================================================================================== AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES ==================================================================================================================== Number of Unexercised Value of Unexercised Options at In-The-Money Options at Year-End Year-End (1) ------------------------- -------------------------- Shares Acquired Value Name Upon Exercise Realized Exercisable/Unexercisable Exercisable/Unexercisable (#) ($) - -------------------------------------------------------------------------------------------------------------------- Kim S. Price.............. -- $-- 19,619 / 13,080 $59,838 / $39,894 - -------------------------------------------------------------------------------------------------------------------- Paul L. Teem, Jr.......... -- $-- 9,125 / 6,083 $27,831 / $18,553 - -------------------------------------------------------------------------------------------------------------------- Michael R. Maguire........ -- $-- 4,000 / 6,000 $8,200 / $12,300 ====================================================================================================================
____________________________ (1) Equals the difference between the aggregate exercise price of such options and the aggregate fair market value of the shares of common stock that would be received upon exercise, assuming such exercise occurred on December 31, 2001, at which date the last trade price of the common stock as quoted on the Nasdaq National Market was $15.05. Transactions With Certain Related Persons Federal law and regulation generally requires that all loans or extensions of credit to executive officers and directors must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with the general public and must not involve more than the normal risk of repayment or present other unfavorable features. However, recent regulations now permit executive officers and directors to receive the same terms through benefit or compensation plans that are widely available to other employees, as long as the director or executive officer is not given preferential treatment compared to the other participating employees. Pursuant to such a program, Citizens South Bank has extended loans to Directors Hoyle, Matthews, and Price. Set forth below is certain information as to loans made by Citizens South Bank to certain of its directors and executive officers, or their affiliates, whose aggregate indebtedness to Citizens South Bank exceeded $60,000 at any time since January 1, 2001. Unless otherwise indicated, all of the loans are secured loans and all loans designated as residential loans are first mortgage loans secured by the borrower's principal place of residence.
Interest Rate Original Highest Balance on on Date Loan Balance December 31, December 31, Name of Individual Loan Type Originated Amount During 2001 2001 2001 - ------------------------- -------------------------- -------------- ----------- ----------- ------------- ------------- Senator David W. Hoyle Residential (refinance) 2/98 $ 191,200 $ 161,842 $ 149,648 5.75% Residential (second home) 5/98 $ 500,000 $ 430,507 $ 400,312 6.00% Home equity line of credit 12/96 $ 100,000 $ 72,799 $ 61,690 Prime + 1% Eugene R. Matthews, II Residential 3/94 $ 148,000 $ 126,155 $ 119,246 5.75% B. Frank Matthews, II (1) Residential 1/98 $ 232,000 $ 200,943 $ 186,821 5.875% Residential 4/98 $ 134,400 $ 115,178 $ 107,161 5.875% Kim S. Price Residential 5/98 $ 375,000 $ 293,797 $ 288,992 5.875%
_______________________________ (1) Borrower is a former Director of Citizens South Bank and the father of Director Eugene R. Matthews, II. 70 Other than as described above, all loans the principal balances of which exceeded $60,000 at any time during the fiscal year ended December 31, 2001, made by Citizens South Bank to executive officers, directors, immediate family members of executive officers and directors, or organizations with which executive officers and directors are affiliated, were made in the ordinary course of business, on substantially the same terms including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. Benefits to Be Considered Following Completion of the Conversion Stock Option Plan. We intend to submit a new stock option plan for stockholder approval no earlier than six months after the completion of the conversion. If approved by the stockholders, the new stock option plan would reserve 10% of the shares sold in the offering for issuance when options granted to recipients are exercised. Ten percent of the shares issued in the offering would amount to 340,000 shares, 400,000 shares, 460,000 shares or 529,000 shares at the minimum, mid-point, maximum and adjusted maximum of the offering range, respectively. No options would be granted under the new stock option plan until stockholder approval of the plan is received. In the event that shares underlying options come from authorized but unissued shares, stockholders would experience dilution of approximately 5.5% in their ownership interest in Citizens South Banking Corporation at the mid-point of the offering range. The exercise price of the options granted under the new stock option plan will be equal to the fair market value of Citizens South Banking Corporation common stock on the date of grant of the stock options. If the stock option plan is adopted within one year following the conversion, options may vest no faster than 20% per year beginning 12 months after the date of grant. Options granted under the stock option plan would be adjusted for capital changes such as stock splits and stock dividends. Awards will be 100% vested upon termination of employment due to death or disability, and if the stock option plan is adopted more than one year after the conversion, awards would be 100% vested upon normal retirement or a change in control of Citizens South Bank or Citizens South Banking Corporation. Under Office of Thrift Supervision rules, if the stock option plan is adopted within one year of the conversion, no individual officer may receive more than 25% of the awards under the plan, no non-employee director may receive more than 5% of the awards under the plan, and all non-employee directors as a group may receive in the aggregate no more than 30% of the awards under the plan. The stock option plan would be administered by a committee of non-employee members of the Citizens South Banking Corporation's Board of Directors. Options granted under the stock option plan to employees may be "incentive" stock options, which are designed to result in a beneficial tax treatment to the employee but no tax deduction to Citizens South Banking Corporation. Non-qualified stock options may also be granted to employees under the stock option plan, and will be granted to the non-employee directors who receive stock options. In the event an option recipient terminated his employment or service as an employee or director, the options would terminate during certain specified periods. Stock Recognition and Retention Plan. We also intend to request stockholder approval of a new stock recognition and retention plan, no earlier than six months after the completion of the conversion. If approved by stockholders, the new stock recognition and retention plan would, if implemented within one year of conversion, reserve 4% of the shares sold in the offering (assuming Citizens South Bank has a tangible capital to assets ratio in excess of 10%) or 136,000 shares, 160,000 shares, 184,000 or 211,600 shares at the minimum, mid-point, maximum and adjusted maximum of the offering range, respectively. We must recognize expense for shares awarded over their vesting period at the fair market value of the shares on the date they are awarded. The recipients will be awarded common stock under the stock recognition and retention plan at no cost to them. No awards would be made under the stock recognition and retention plan until the plan is approved by stockholders. If the shares awarded under the stock recognition and retention plan come from authorized but unissued shares totaling 4% of the shares sold in the offering, stockholders would experience dilution of approximately 2.3% in their ownership interest in Citizens South Banking Corporation at the mid-point of the offering range. Awards under the stock recognition and retention plan would be nontransferable and nonassignable. Under Office of Thrift Supervision regulations, if the stock recognition and retention plan is adopted within one year following the conversion, the shares which are subject to an award may vest no faster than 20% per year beginning 12 months after the date of grant of the award. Awards would be adjusted for capital changes such as stock dividends and stock splits. Awards would be 100% vested upon termination of employment or service due to death 71 or disability, and if the stock recognition and retention plan is adopted more than one year after the conversion, awards would be 100% vested upon normal retirement or a change in control of Citizens South Bank or Citizens South Banking Corporation. If employment or service were to terminate for other reasons, the award recipient would forfeit any nonvested award. If employment or service were to terminate for cause (as defined), shares not already delivered would be forfeited. Under Office of Thrift Supervision rules, if the stock recognition and retention plan is adopted within one year of the conversion, no individual officer may receive more than 25% of the awards under the plan, no non-employee director may receive more than 5% of the awards under the plan, and all non-employee directors as a group may receive no more than 30% of the awards under the plan in the aggregate. The recipient of an award will recognize income equal to the fair market value of the stock earned, determined as of the date of vesting, unless the recipient makes an election under Section 83(b) of the Internal Revenue Code to be taxed earlier. The amount of income recognized by the recipient would be a deductible expense for tax purposes for Citizens South Banking Corporation. If the stock recognition and retention plan is adopted within one year following the conversion, dividends and other earnings will accrue and be payable to the award recipient when the shares vest. If the stock recognition and retention plan is adopted within one year following the conversion, shares not yet vested will be voted by the trustee of the stock recognition and retention plan, taking into account the best interests of the award recipients. If the stock recognition and retention plan is adopted more than one year following the conversion, dividends declared on unvested shares will be distributed to the recipient when paid and the recipient will be entitled to vote the unvested shares. BENEFICIAL OWNERSHIP OF COMMON STOCK The following table provides the beneficial ownership of our common stock held by our directors and executive officers, individually and as a group as of August __, 2002. The business address of each director and executive officer is 245 West Main Avenue, Gastonia, North Carolina 28053-2249.
Number of Shares of Common Percent of All Common Name of Beneficial Owner Stock Beneficially Owned (1) (2) Stock Outstanding (4) - --------------------------------------- ---------------------------------- ----------------------------- All directors and executive officers as a group (12 persons)
___________________________ (1) In accordance with Rule 13d-3 under the Securities Exchange Act of 1934, a person is deemed to be the beneficial owner for purposes of this table of any shares of common stock if he has sole or shared voting or investment power with respect to such security, or has a right to acquire beneficial ownership at any time within 60 days from the date as of which beneficial ownership is being determined. As used herein, "voting power" is the power to vote or direct the voting of shares and "investment power" is the power to dispose or direct the disposition of shares. Includes all shares held directly as well as by spouses and minor children, in trust and other indirect ownership, over which shares the named individuals effectively exercise sole or shared voting and investment power. (2) The shares of common stock in this column include _______ shares in total and by individual the following shares which may be acquired by the persons indicated pursuant to the exercise of stock options within 60 days of August __, 2002: [ ] (3) Excludes _______ shares of common stock owned by the employee stock ownership plan for the benefit of the employees of Citizens South Banking Corporation and Citizens South Bank. (4) Calculated by dividing the number of shares by the total shares of common stock outstanding at August __, 2002 (_________ shares) plus the number of shares which each individual may acquire pursuant to the exercise of stock options within 60 days of August __, 2002. * Less than 1%. 72 SUBSCRIPTIONS BY EXECUTIVE OFFICERS AND DIRECTORS The table below sets forth, for each of Citizens South Banking Corporation's directors and executive officers and for all of the directors and executive officers as a group, the following information: (1) the number of exchange shares to be held upon consummation of the conversion, based upon their beneficial ownership of Citizens South Banking Corporation common stock as of August __, 2002; (2) the proposed purchases of subscription shares, assuming sufficient shares are available to satisfy their subscriptions; and (3) the total amount of Citizens South Banking Corporation common stock to be held upon consummation of the conversion. In each case, it is assumed that subscription shares are sold at the midpoint of the offering range. See "The Conversion--Limitations on Common Stock Purchases."
Proposed Purchases of Stock in the Offering (1) Total Common Stock to be Held ---------------------------- ------------------------------ Number of Percentage of Exchange Shares Number of Number of Total Name of Beneficial Owner to be Held (2) Shares Amount Shares Outstanding - -------------------------- ----------------- ------------- ------------- ------------- ---------------
________________ * Less than 1%. (1) Includes proposed subscriptions, if any, by associates. (2) Based on information presented in "Beneficial Ownership of Common Stock." THE CONVERSION The Boards of Directors of Citizens South Banking Corporation and Citizens South Holdings, MHC have approved the plan of conversion. The plan of conversion must also be approved by the members of Citizens South Holdings, MHC (depositors of Citizens South Bank) and the stockholders of Citizens South Banking Corporation. A special meeting of members and a special meeting of stockholders have been called for this purpose. The Office of Thrift Supervision also has conditionally approved the plan; however, such approval does not constitute a recommendation or endorsement of the plan of conversion by that agency. General The respective Boards of Directors of Citizens South Holdings, MHC and Citizens South Banking Corporation adopted the plan of conversion on May 23, 2002. Pursuant to the plan of conversion, our organization will convert from the mutual holding company form of organization to the fully public form. Citizens South Holdings, MHC, the mutual holding company parent of Citizens South Banking Corporation, will be merged into Citizens South Bank, and Citizens South Holdings, MHC will no longer exist. Pursuant to the plan, Citizens South 73 Banking Corporation, which owns 100% of Citizens South Bank, also will be succeeded by a new Delaware corporation with the same name. As part of the conversion, shares of common stock of Citizens South Banking Corporation representing the ownership interest of Citizens South Holdings, MHC, will be offered for sale in the offering. When the conversion is completed, all of the capital stock of Citizens South Bank will be owned by Citizens South Banking Corporation. A diagram of our corporate structure before and after the conversion is set forth in the Summary of this prospectus. Under the plan of conversion, at the conclusion of the conversion and offering, each share of Citizens South Banking Corporation common stock owned by persons other than Citizens South Holdings, MHC will be converted automatically into the right to receive new shares of Citizens South Banking Corporation common stock determined pursuant to the exchange ratio. The exchange ratio will ensure that immediately after the conversion and exchange of existing shares of Citizens South Banking Corporation for new shares, the public stockholders of Citizens South Banking Corporation common stock will own the same aggregate percentage of new Citizens South Banking Corporation common stock that they owned immediately prior to the conversion, excluding any shares purchased in the offering. We intend to retain 50% of the net proceeds of the offering and to contribute the balance of the net proceeds to Citizens South Bank. The conversion will be effected only upon completion of the sale of at least the minimum number of shares of our common stock to be offered pursuant to the plan of conversion. The plan of conversion provides generally that we will offer shares of common stock for sale in the subscription offering to eligible account holders, our tax-qualified benefit plans, including the employee stock ownership plan, supplemental eligible account holders and other members. Subject to the prior rights of these holders of subscription rights, we will offer common stock for sale in a community offering to members of the general public, with a preference given in the following order: (1) First, to public stockholders of Citizens South Banking Corporation common stock as of July 31, 2002; and (2) Second, to natural persons residing in the North Carolina Counties of Gaston, Rowan, Iredell, Mecklenburg, Cabarrus, Cleveland and Lincoln and the South Carolina County of York. We have the right to accept or reject, in whole or in part, any orders to purchase shares of the common stock received in the community offering. The community offering may begin at the same time as the subscription offering and must be completed within 45 days after the completion of the subscription offering unless otherwise extended by the Office of Thrift Supervision. See "--Community Offering." We determined the number of shares of common stock to be offered in the offering based upon an independent appraisal of the estimated pro forma market value of Citizens South Banking Corporation. All shares of common stock to be sold in the offering will be sold at $10.00 per share. The independent valuation will be updated and the final number of the shares to be issued in the offering will be determined at the completion of the offering. See "--Stock Pricing and Number of Shares to be Issued" for more information as to the determination of the estimated pro forma market value of the common stock. The following is a brief summary of the conversion and is qualified in its entirety by reference to the provisions of the plan of conversion. A copy of the plan of conversion is available for inspection at each branch of Citizens South Bank and at the Southeast Regional and Washington, D.C. offices of the Office of Thrift Supervision. The plan of conversion is also filed as an exhibit to the application to convert from mutual to stock form of which this prospectus is a part, copies of which may be obtained from the Office of Thrift Supervision. See "Additional Information." Reasons for the Conversion The primary reasons for the conversion are to facilitate acquisitions of other financial institutions and financial services companies as opportunities arise, to support internal growth through lending in communities we serve, to improve our overall competitive position and to enhance shareholder returns through higher earnings and capital management strategies. 74 As a fully converted stock holding company, we will have greater flexibility in structuring mergers and acquisitions, including the form of consideration paid in a transaction. In our current mutual holding company structure, our ability to offer our common stock as consideration for a merger or acquisition has been limited. Potential sellers often want stock for at least part of the purchase price. Our new stock holding company structure will enhance our ability to compete with other bidders when acquisition opportunities arise by enabling us to offer stock or cash consideration, or a combination thereof. We do not now have any specific acquisition or expansion plans. Approvals Required The affirmative vote of a majority of the total eligible votes of the members of Citizens South Holdings, MHC at the special meeting of members is required to approve the plan of conversion. By their approval of the plan of conversion, the members of Citizens South Holdings, MHC will also be deemed to approve the merger of Citizens South Holdings, MHC into Citizens South Bank. The affirmative vote of the holders of at least two-thirds of the outstanding shares of common stock of Citizens South Banking Corporation and a majority of the votes cast by the public stockholders of Citizens South Banking Corporation common stock also are required to approve the plan of conversion. The plan of conversion also must be approved by the Office of Thrift Supervision, which has given its conditional approval. Share Exchange Ratio Office of Thrift Supervision regulations provide that in a conversion of a mutual holding company to fully stock form, the public stockholders will be entitled to exchange their shares for common stock of the converted holding company, provided that the mutual holding company demonstrates to the satisfaction of the Office of Thrift Supervision that the basis for the exchange is fair and reasonable. The Board of Directors of Citizens South Banking Corporation has determined that each publicly held share of Citizens South Banking Corporation common stock will, on the effective date of the conversion, be converted automatically into and become the right to receive a number of new shares of Citizens South Banking Corporation common stock. The number of new shares of common stock will be determined pursuant to the exchange ratio which ensures that the public stockholders of Citizens South Banking Corporation common stock will own the same percentage of new common stock in Citizens South Banking Corporation after the conversion as they held in Citizens South Banking Corporation immediately prior to the conversion, exclusive of their purchase of additional shares, and the receipt of cash in lieu of fractional shares. At March 31, 2002, there were 4,209,434 shares of Citizens South Banking Corporation common stock outstanding (net of treasury stock), and 1,752,427 shares were publicly held. The exchange ratio is not dependent on the market value of Citizens South Banking Corporation common stock. It is calculated based on the percentage of Citizens South Banking Corporation common stock held by the public, the independent appraisal of Citizens South Banking Corporation prepared by RP Financial, LC and the number of shares sold in the offering. The exchange ratio is expected to range from approximately 1.3838 exchange shares for each publicly held share of Citizens South Banking Corporation at the minimum of the offering range to 2.1530 exchange shares for each publicly held share of Citizens South Banking Corporation at the adjusted maximum of the offering range. If you are now a stockholder of Citizens South Banking Corporation, your existing shares will be cancelled and exchanged for new shares of Citizens South Banking Corporation. The number of shares you receive will be based on the exchange ratio determined as of the closing of the conversion. The actual number of shares you receive will depend upon the number of shares we sell in the offering, which in turn will depend upon the final appraised value of Citizens South Banking Corporation. The following table shows how the exchange ratio will adjust, based on the number of shares sold in the offering. The table also shows how many shares an owner of Citizens South Banking Corporation common stock would receive in the exchange, adjusted for the number of shares sold in the offering. 75
New Shares to be Exchanged for Existing Shares of New Shares to be Sold Citizens South Banking New Shares to in This Offering Corporation Total Shares of be Received for ----------------------- -------------------------- Common Stock to Exchange 100 Existing Amount Percent Amount Percent be Outstanding Ratio Shares ---------- ----------- ----------- ------------ ----------------- ------------ ----------------- Minimum .......... 3,400,000 58.4% 2,425,004 41.6% 5,825,004 1.3838 138.38 Midpoint ......... 4,000,000 58.4% 2,852,946 41.6% 6,852,946 1.6280 162.80 Maximum .......... 4,600,000 58.4% 3,280,888 41.6% 7,880,888 1.8722 187.22 15% above Maximum ......... 5,290,000 58.4% 3,773,021 41.6% 9,063,021 2.1530 215.30
Options to purchase shares of Citizens South Banking Corporation common stock also will be converted into and become options to purchase Citizens South Banking Corporation common stock. The number of shares of common stock to be received upon exercise of these options will be determined pursuant to the exchange ratio. The aggregate exercise price, duration and vesting schedule of these options will not be affected. At March 31, 2002, there were 201,748 outstanding options to purchase Citizens South Banking Corporation common stock, 161,598 of which were vested. Effects of Conversion on Depositors, Borrowers and Members Continuity. While the conversion is being accomplished, the normal business of Citizens South Bank of accepting deposits and making loans will continue without interruption. Citizens South Bank will continue to be a federally chartered savings bank and will continue to be regulated by the Office of Thrift Supervision. After the conversion, Citizens South Bank will continue to offer existing services to depositors, borrowers and other customers. The directors serving Citizens South Banking Corporation at the time of the conversion will serve as directors of Citizens South Banking Corporation after the conversion. Effect on Deposit Accounts. Under the plan of conversion, each depositor in Citizens South Bank at the time of the conversion will automatically continue as a depositor after the conversion, and each of the deposit accounts will remain the same with respect to deposit balance, interest rate and other terms. Each such account will be insured by the Federal Deposit Insurance Corporation to the same extent as before the conversion. Depositors will continue to hold their existing certificates, passbooks and other evidences of their accounts. Effect on Loans. No loan outstanding from Citizens South Bank will be affected by the conversion, and the amount, interest rate, maturity and security for each loan will remain as it was contractually fixed prior to the conversion. Effect on Voting Rights of Members. At present, all depositors are members of, and have voting rights in, Citizens South Holdings, MHC as to all matters requiring membership action. Upon completion of the conversion, depositors will cease to be members of Citizens South Holdings, MHC and will no longer have voting rights. Upon completion of the conversion, all voting rights in Citizens South Bank will be vested in Citizens South Banking Corporation as the sole stockholder of Citizens South Bank. The stockholders of Citizens South Banking Corporation will possess exclusive voting rights with respect to Citizens South Banking Corporation common stock. Tax Effects. Citizens South Banking Corporation will receive an opinion of counsel or tax advisor with regard to federal and state income taxation to the effect that the conversion will not be taxable for federal or state income tax purposes to Citizens South Holdings, MHC, Citizens South Banking Corporation, the public stockholders of Citizens South Banking Corporation, members of Citizens South Holdings, MHC, eligible account holders, supplemental eligible account holders, or Citizens South Bank. See "--Tax Aspects." Effect on Liquidation Rights. Each depositor in Citizens South Bank has both a deposit account in Citizens South Bank and a pro rata ownership interest in the net worth of Citizens South Holdings, MHC based upon the balance in his or her account. This interest may only be realized in the event of a complete liquidation of Citizens South Holdings, MHC and Citizens South Bank. However, this ownership interest is tied to the depositor's account and has no tangible market value separate from the deposit account. Any depositor who opens a deposit account obtains a pro rata ownership interest in Citizens South Holdings, MHC without any additional payment beyond the amount of the deposit. A depositor who reduces or closes his account receives a portion or all of the balance in the 76 deposit account but nothing for his ownership interest in the net worth of Citizens South Holdings, MHC, which is lost to the extent that the balance in the account is reduced or closed. Consequently, depositors in a stock subsidiary of a mutual holding company normally have no way of realizing the value of their ownership interest, which has realizable value only in the unlikely event that Citizens South Holdings, MHC and Citizens South Bank are liquidated. If this occurs, the depositors of record at that time, as owners, would share pro rata in any residual surplus and reserves of Citizens South Holdings, MHC after other claims, including claims of depositors to the amounts of their deposits, are paid. In the unlikely event that Citizens South Bank were to liquidate after the conversion, all claims of creditors, including those of depositors, also would be paid first, followed by distribution of the "liquidation account" to depositors as of March 31, 2001 and June 30, 2002 who continue to maintain their deposit accounts as of the date of liquidation, with any assets remaining thereafter distributed to Citizens South Banking Corporation as the holder of Citizens South Bank's capital stock. Pursuant to the rules and regulations of the Office of Thrift Supervision, a post-conversion merger, consolidation, sale of bulk assets or similar combination or transaction with another insured savings institution would not be considered a liquidation and, in such a transaction, the liquidation account would be assumed by the surviving institution. See "--Liquidation Rights." Stock Pricing and Number of Shares to be Issued The plan of conversion and federal regulations require that the aggregate purchase price of the common stock sold in the offering must be based on the appraised pro forma market value of the common stock, as determined by an independent valuation. Citizens South Bank and Citizens South Banking Corporation have retained RP Financial, LC to make this valuation. For its services in preparing the initial valuation, RP Financial, LC will receive a fee of $40,000. This amount does not include a fee of $10,000 to be paid to RP Financial, LC for assistance in the preparation of a business plan. Citizens South Bank and Citizens South Banking Corporation have agreed to indemnify RP Financial, LC and its employees and affiliates against specified losses, including any losses in connection with claims under the federal securities laws, arising out of its services as appraiser, except where RP Financial, LC's liability results from its negligence or bad faith. The appraisal considered the pro forma impact of the offering. Consistent with the Office of Thrift Supervision appraisal guidelines, the appraisal applied three primary methodologies: the pro forma price-to-book value approach applied to both reported book value and tangible book value; the pro forma price-to-earnings approach applied to reported and core earnings; and the pro forma price-to-assets approach. The market value ratios applied in the three methodologies were based upon the current market valuations of the peer group companies, subject to valuation adjustments applied by RP Financial, LC to account for differences between Citizens South Banking Corporation and the peer group. RP Financial, LC placed the greatest emphasis on the price-to-earnings and price-to-book approaches in estimating pro forma market value. The independent valuation was prepared by RP Financial, LC in reliance upon the information contained in this prospectus, including the consolidated financial statements. RP Financial, LC also considered the following factors, among others: . the present and projected operating results and financial condition of Citizens South Banking Corporation; . the economic and demographic conditions in Citizens South Banking Corporation's existing market area; . certain historical, financial and other information relating to Citizens South Banking Corporation; . a comparative evaluation of the operating and financial characteristics of Citizens South Banking Corporation with those of other similarly situated publicly traded savings institutions located in North Carolina and other regions of the United States; 77 . the aggregate size of the offering of the common stock; . the impact of the conversion on Citizens South Banking Corporation's stockholders' equity and earnings potential; . the proposed dividend policy of Citizens South Banking Corporation; and . the trading market for securities of comparable institutions and general conditions in the market for such securities. Included in RP Financial, LC's report were certain assumptions as to the pro forma earnings of Citizens South Banking Corporation after the conversion that were utilized in determining the appraised value. These assumptions included estimated expenses, an assumed after-tax rate of return on the net conversion proceeds and purchases in the open market of 4% of the common stock issued in the offering by the recognition and retention plan at the $10.00 purchase price. See "Pro Forma Data" for additional information concerning theses assumptions. The use of different assumptions may yield different results. The independent valuation states that as of June 14, 2002, the estimated pro forma market value, or valuation range, of Citizens South Banking Corporation ranged from a minimum of $58.3 million to a maximum of $78.8 million, with a midpoint of $68.5 million. The Board of Directors decided to offer the shares for a price of $10.00 per share. The aggregate offering price of the shares will be equal to the valuation range multiplied by the percentage of Citizens South Banking Corporation common stock owned by Citizens South Holdings, MHC. The number of shares offered will be equal to the aggregate offering price of the shares divided by the price per share. Based on the valuation range, the percentage of Citizens South Banking Corporation common stock owned by Citizens South Holdings, MHC and the $10.00 price per share, the minimum of the offering range will be 3,400,000 shares, the midpoint of the offering range will be 4,000,000 shares and the maximum of the offering range will be 4,600,000 shares. The Board of Directors reviewed the independent valuation and, in particular, considered the following: . Citizens South Banking Corporation's financial condition and results of operations; . comparison of financial performance ratios of Citizens South Banking Corporation to those of other financial institutions of similar size; . stock market conditions generally and in particular for financial institutions; and . the historical trading price of the publicly held shares of Citizens South Banking Corporation common stock. All of these factors are set forth in the independent valuation. The Board also reviewed the methodology and the assumptions used by RP Financial, LC in preparing the independent valuation and the Board believes that such assumptions were reasonable. The offering range may be amended with the approval of the Office of Thrift Supervision, if required, as a result of subsequent developments in the financial condition of Citizens South Banking Corporation or Citizens South Bank or market conditions generally. In the event the independent valuation is updated to amend the pro forma market value of Citizens South Banking Corporation to less than $58.3 million or more than $90.6 million, the appraisal will be filed with the Securities and Exchange Commission by post-effective amendment. The independent valuation is not intended, and must not be construed, as a recommendation of any kind as to the advisability of purchasing our common stock. RP Financial, LC did not independently verify our consolidated financial statements and other information that we provided to them, nor did RP Financial, LC independently value our assets or liabilities. The independent valuation considers Citizens South Bank as a going concern and should not be considered as an indication of the liquidation value of Citizens South Bank. Moreover, because the valuation is necessarily based upon estimates and projections of a number of 78 matters, all of which may change from time to time, no assurance can be given that persons purchasing our common stock in the offering will thereafter be able to sell their shares at prices at or above the $10.00 price. Following commencement of the subscription offering, the maximum of the valuation range may be increased by up to 15% to up to $90.6 million, which will result in a corresponding increase of up to 15% in the maximum of the offering range to up to 5,290,000 shares, to reflect changes in the market and financial conditions, without resoliciting subscribers. We will not decrease the minimum of the valuation range and the minimum of the offering range without a resolicitation of subscribers. The subscription price of $10.00 per share will remain fixed. See "--Limitations on Common Stock Purchases" as to the method of distribution and allocation of additional shares that may be issued in the event of an increase in the offering range to fill unfilled orders in the offering. If the update to the independent valuation at the conclusion of the offering results in an increase in the maximum of the valuation range to more than $90.6 million and a corresponding increase in the offering range to more than 5,290,000 shares, or a decrease in the minimum of the valuation range to less than $58.3 million and a corresponding decrease in the offering range to fewer than 3,400,000 shares, then, after consulting with the Office of Thrift Supervision, we may terminate the plan of conversion, cancel withdrawal authorizations and return by check all funds received promptly with interest at Citizens South Bank's passbook savings rate of interest. Alternatively, we may hold a new offering, establish a new offering range, extend the offering period and commence a resolicitation of subscribers or take other actions as permitted by the Office of Thrift Supervision in order to complete the conversion. In the event that a resolicitation is commenced, unless we receive an affirmative response within a reasonable period of time, we will return all funds promptly to investors as described above. Any resolicitation following the conclusion of the subscription and community offerings would not exceed 45 days unless further extended by the Office of Thrift Supervision for periods of up to 90 days. An increase in the number of shares to be issued in the offering would decrease both a subscriber's ownership interest and Citizens South Banking Corporation's pro forma earnings and stockholders' equity on a per share basis while increasing pro forma earnings and stockholders' equity on an aggregate basis. A decrease in the number of shares to be issued in the offering would increase both a subscriber's ownership interest and Citizens South Banking Corporation's pro forma earnings and stockholders' equity on a per share basis, while decreasing pro forma earnings and stockholders' equity on an aggregate basis. For a presentation of the effects of these changes, see "Pro Forma Data." Copies of the appraisal report of RP Financial, LC and the detailed memorandum of the appraiser setting forth the method and assumptions for the appraisal are available for inspection at the main office of Citizens South Bank and as specified under "Additional Information." Exchange of Stock Certificates The conversion of existing outstanding shares of Citizens South Banking Corporation common stock into the right to receive new shares of Citizens South Banking Corporation common stock will occur automatically on the effective date of the conversion. As soon as practicable after the effective date of the conversion, we or a bank or trust company designated by us in the capacity of exchange agent, will send a transmittal form to each public stockholder of Citizens South Banking Corporation who holds stock certificates. The transmittal forms are expected to be mailed within five business days after the effective date of the conversion and will contain instructions on how to exchange old shares of Citizens South Banking Corporation common stock, which may bear the company's former name of Gaston Federal Bancorp, Inc., for new shares of Citizens South Banking Corporation common stock. We expect that stock certificates for new shares of Citizens South Banking Corporation common stock will be distributed within five business days after we receive properly executed transmittal forms and other required documents. Shares held by public stockholders in street name will be exchanged automatically upon the effective date; no transmittal forms will be mailed relating to these shares. New shares of Citizens South Banking Corporation issued in exchange for existing shares are considered acquired in an initial public offering. Accordingly, such new shares offering cannot be owned on margin for 30 days after the offering. If a shareholder currently owns our stock on margin, the shares would have to be moved to a cash account prior to exchanging the old stock certificates for new stock certificates. 79 No fractional shares of Citizens South Banking Corporation common stock will be issued to any public stockholder of Citizens South Banking Corporation when the conversion is completed. For each fractional share that would otherwise be issued to stockholders who hold certificates, we will pay by check an amount equal to the product obtained by multiplying the fractional share interest to which the holder would otherwise be entitled to by $10.00. Payment for fractional shares will be made as soon as practicable after the receipt by the exchange agent of surrendered Citizens South Banking Corporation stock certificates. If your shares are held in street name, you will automatically receive cash in lieu of fractional shares. You should not forward your stock certificates until you have received transmittal forms, which will include forwarding instructions. Until your existing certificates representing Citizens South Banking Corporation common stock are surrendered for exchange after the conversion in compliance with the terms of the transmittal form, you will not receive new shares of Citizens South Banking Corporation common stock and you will not be paid dividends on the new Citizens South Banking Corporation common stock. When you surrender your certificates, any unpaid dividends will be paid without interest. For all other purposes, however, each certificate which represents shares of Citizens South Banking Corporation common stock outstanding at the effective date of the conversion will be considered to evidence ownership of new shares of Citizens South Banking Corporation common stock into which those shares have been converted by virtue of the conversion. All new shares of Citizens South Banking Corporation common stock that we issue to you in exchange for existing shares of Citizens South Banking Corporation common stock will be considered to have been issued in full satisfaction of all rights pertaining to such shares, subject, however, to our obligation to pay any dividends or make any other distributions with a record date prior to the effective date of the conversion which may have been declared by us on or prior to the effective date and which remain unpaid at the effective date. If a certificate for Citizens South Banking Corporation common stock has been lost, stolen or destroyed, the exchange agent will issue a new stock certificate upon receipt of appropriate evidence as to the loss, theft or destruction, appropriate evidence as to the ownership of the certificate by the claimant, and appropriate and customary indemnification, which is normally effected by the purchase of a bond from a surety company at the shareholder's expense. Subscription Offering and Subscription Rights In accordance with the plan of conversion, rights to subscribe for the purchase of common stock in the subscription offering have been granted under the plan of conversion in the following descending order of priority. The filling of all subscriptions that we receive will depend on the availability of common stock after satisfaction of all subscriptions of all persons having prior rights in the subscription offering and to the maximum, minimum and overall purchase limitations set forth in the plan of conversion and as described below under "--Limitations on Common Stock Purchases." Priority 1: Eligible Account Holders. Each Citizens South Bank depositor with aggregate deposit account balances, including demand deposit accounts, of $50 or more (a "Qualifying Deposit") on March 31, 2001 ("Eligible Account Holders") will receive, without payment therefor, nontransferable subscription rights to purchase up to 50,000 shares of common stock, subject to the overall purchase limitations. See "--Limitations on Common Stock Purchases." If there are not sufficient shares available to satisfy all subscriptions, shares will first be allocated so as to permit each subscribing Eligible Account Holder to purchase a number of shares sufficient to make his total allocation equal to the lesser of 100 shares or the number of shares for which he subscribed. Thereafter, unallocated shares will be allocated to each subscribing Eligible Account Holder whose subscription remains unfilled in the proportion that the amount of his Qualifying Deposit bears to the total amount of Qualifying Deposits of all subscribing Eligible Account Holders whose subscriptions remain unfilled. If an amount so allocated exceeds the amount subscribed for by any one or more Eligible Account Holders, the excess shall be reallocated among those Eligible Account Holders whose subscriptions are not fully satisfied until all available shares have been allocated. To ensure proper allocation of stock, each Eligible Account Holder must list on his stock order form all deposit accounts in which he has an ownership interest on March 31, 2001. Failure to list an account could result in 80 fewer shares being allocated than if all accounts had been disclosed. The subscription rights of Eligible Account Holders who are also directors or officers of Citizens South Banking Corporation or their associates will be subordinated to the subscription rights of other Eligible Account Holders to the extent attributable to increased deposits in the twelve months preceding March 31, 2001. Priority 2: Tax-Qualified Plans. Our tax-qualified employee stock benefit plans will receive, without payment therefor, nontransferable subscription rights to purchase in the aggregate up to 8% of the common stock sold in the offering (although we anticipate our employee stock ownership plan will purchase 2% of the common stock sold in the offering). Priority 3: Supplemental Eligible Account Holders. To the extent that there are sufficient shares remaining after satisfaction of subscriptions by Eligible Account Holders and our tax-qualified employee stock benefit plans, each Citizens South Bank depositor with a Qualifying Deposit on June 30, 2002 who is not an Eligible Account Holder ("Supplemental Eligible Account Holder") will receive, without payment therefor, nontransferable subscription rights to purchase up to 50,000 shares of common stock, subject to the overall purchase limitations. See "--Limitations on Common Stock Purchases." If there are not sufficient shares available to satisfy all subscriptions, shares will be allocated so as to permit each subscribing Supplemental Eligible Account Holder to purchase a number of shares sufficient to make his total allocation equal to the lesser of 100 shares or the number of shares for which he subscribed. Thereafter, unallocated shares will be allocated to each subscribing Supplemental Eligible Account Holder whose subscription remains unfilled in the proportion that the amount of his Qualifying Deposit bears to the total amount of Qualifying Deposits of all subscribing Supplemental Eligible Account Holders whose subscriptions remain unfilled. To ensure proper allocation of stock, each Supplemental Eligible Account Holder must list on his stock order form all deposit accounts in which he has an ownership interest at June 30, 2002. Failure to list an account could result in less shares being allocated than if all accounts had been disclosed. Priority 4: Other Members. To the extent that there are shares remaining after satisfaction of subscriptions by Eligible Account Holders, our tax-qualified employee stock benefit plans, and Supplemental Eligible Account Holders, each member of Citizens South Holdings, MHC (depositor of Citizens South Bank) on the voting record date of July 31, 2002 who is not an Eligible Account Holder or Supplemental Eligible Account Holder ("Other Members") will receive, without payment therefor, nontransferable subscription rights to purchase up to 50,000 shares of common stock, subject to the overall purchase limitations. See "--Limitations on Common Stock Purchases." If there are not sufficient shares available to satisfy all subscriptions, available shares will be allocated on a pro rata basis based on the size of the order of each Other Member. Expiration Date for the Subscription Offering. The Subscription Offering will expire at 12:00 noon, North Carolina Time, on September 18, 2002, unless extended by us for up to 45 days or such additional periods with the approval of the Office of Thrift Supervision, if necessary. We may decide to extend the subscription offering and/or the community offering for any reason, whether or not subscriptions have been received for shares at the minimum, midpoint or maximum of the offering range. Subscription rights which have not been exercised prior to the expiration date will become void. We will not execute orders until at least the minimum number of shares of common stock have been subscribed for or otherwise sold. If at least 3,400,000 shares have not been subscribed for or sold within 45 days after the expiration date, unless the period is extended with the consent of the Office of Thrift Supervision, all funds delivered to us pursuant to the offering will be returned promptly to the subscribers with interest and all withdrawal authorizations will be cancelled. If an extension beyond the 45-day period following the expiration date is granted, we will notify subscribers of the extension of time and of the rights of subscribers to modify or rescind their subscriptions. Extensions may not go beyond September __, 2004 which is two years after the special meeting of members of Citizens South Holdings, MHC to approve the conversion. Community Offering To the extent that shares remain available for purchase after satisfaction of all subscriptions of the Eligible Account Holders, our tax-qualified employee stock benefit plans, Supplemental Eligible Account Holders and Other 81 Members, we may offer shares pursuant to the plan of conversion to members of the general public in a community offering. Shares may be offered with the following preferences: (1) First, to public stockholders of Citizens South Banking Corporation common stock as of July 31, 2002; and (2) Second, to natural persons residing in the North Carolina Counties of Gaston, Rowan, Iredell, Mecklenburg, Cabarrus, Cleveland and Lincoln and the South Carolina County of York. Subscribers in the community offering may purchase up to 50,000 shares of common stock, subject to the overall purchase limitations. See "--Limitations on Common Stock Purchases." The minimum purchase is 25 shares. The opportunity to purchase shares of common stock in the community offering category is subject to our right, in our sole discretion, to accept or reject any such orders in whole or in part either at the time of receipt of an order or as soon as practicable following the expiration date. If we do not have sufficient shares available to fill the orders of public stockholders of Citizens South Banking Corporation as of July 31, 2002, we will allocate the remaining available shares among those persons in a manner that permits each of them, to the extent possible, to purchase the lesser of 100 shares or the number of shares subscribed for by each such person. Thereafter, unallocated shares will be allocated among public stockholders whose orders remain unsatisfied based on the size of the unfilled order of each public stockholder of Citizens South Banking Corporation relative to the size of the aggregate unfilled orders of other public stockholders. If oversubscription occurs due to the orders of natural persons residing in the North Carolina counties of Gaston, Rowan, Iredell, Mecklenburg, Cabarrus, Cleveland and Lincoln or the South Carolina County of York, the allocation procedures described above will apply to the stock orders of such persons. If oversubscription occurs due to the orders of members of the general public, the allocation procedures described above will apply to the stock orders of such persons. The term "residing" or "resident" as used in this prospectus means any person who occupies a dwelling within the North Carolina counties of Gaston, Rowan, Iredell, Mecklenburg, Cabarrus, Cleveland and Lincoln or the South Carolina County of York, has a present intent to remain within this community for a period of time, and manifests the genuineness of that intent by establishing an ongoing physical presence within the community, together with an indication that this presence within Citizens South Bank's community is something other than merely transitory in nature. We may utilize deposit or loan records or other evidence provided to us to decide whether a person is a resident. In all cases, however, the determination shall be in our sole discretion. The community offering may begin with or during the subscription offering and is expected to terminate at the same time as the subscription offering, and must terminate no more than 45 days following the subscription offering. Citizens South Banking Corporation may decide to extend the community offering for any reason and is not required to give purchasers notice of any such extension. If 3,400,000 shares have not been subscribed for or sold within 45 days after the expiration date, unless this period is extended with the consent of the Office of Thrift Supervision, all funds delivered to us will be returned promptly to the purchasers with interest and all withdrawal authorizations will be cancelled. If an extension beyond the 45-day period following the expiration date is granted, we will notify purchasers of the extension of time and of the rights of purchasers to modify or rescind their orders. These extensions may not go beyond September __, 2004, which is two years after the special meeting of members of Citizens South Holdings, MHC to approve the conversion. We have the right to reject any order submitted in the offering by a person who we believe is making false representations or who we otherwise believe, either alone or acting in concert with others, is violating, evading, circumventing, or intends to violate, evade or circumvent the terms and conditions of the plan of conversion. Syndicated Community Offering If feasible, our Board of Directors may decide to offer for sale all shares of common stock not subscribed for or purchased in the subscription and community offerings in a syndicated community offering, subject to such terms, conditions and procedures as we may determine, in a manner that will achieve the widest distribution of the common stock. However, we retain the right to accept or reject in whole or in part any orders in the syndicated community offering. In the syndicated community offering, any person may purchase up to 50,000 shares of 82 common stock, subject to the overall maximum purchase limitations. Unless the syndicated community offering begins during the community offering, the syndicated community offering will begin as soon as possible after the completion of the subscription and community offerings. If for any reason we cannot effect a syndicated community offering of shares not sold in the subscription and community offerings, or in the event that there is an insignificant number of unsold shares remaining after the subscription and community offerings or in the syndicated community offering, we will try to make other arrangements for the sale of unsubscribed shares, if possible. The Office of Thrift Supervision must approve any such arrangements. Limitations on Common Stock Purchases The plan of conversion includes the following limitations on the number of shares of common stock that may be purchased during the conversion: (1) No person may purchase fewer than 25 shares of common stock or more than 50,000 shares; (2) Our tax-qualified employee stock benefit plans, including our employee stock ownership plan, may purchase in the aggregate up to 8% of the shares issued in the offering, including shares issued in the event of an increase in the offering range of up to 15%. We expect our employee stock ownership plan to subscribe for 2% of the shares sold in the offering; (3) Except for the employee stock ownership plan, as described above, no person or entity, together with associates or persons acting in concert with such person or entity, may purchase more than 50,000 shares in all categories of the offering combined; (4) Current stockholders of Citizens South Banking Corporation are subject to an ownership limitation. As previously described, current stockholders of Citizens South Banking Corporation will receive new shares of Citizens South Banking Corporation common stock in exchange for their existing shares of Citizens South Banking Corporation common stock. The number of shares that a stockholder may purchase in the offering, together with associates or persons acting in concert with such stockholder, when combined with the shares that the stockholder and his associates will receive in exchange for existing Citizens South Banking Corporation common stock, may not exceed 175,000 shares; and (5) The maximum number of shares of common stock that may be purchased in all categories of the offering by officers and directors of Citizens South Bank and their associates, in the aggregate, when combined with new shares of common stock issued in exchange for existing shares, may not exceed 25% of the shares issued in the conversion. Depending upon market or financial conditions, our Board of Directors, with the approval of the Office of Thrift Supervision and without further approval of members of Citizens South Holdings, MHC, may decrease or increase the purchase and ownership limitations. If a purchase limitation is increased, subscribers in the subscription offering who ordered the maximum amount will be, and some other large subscribers who through their subscriptions evidence a desire to purchase the maximum allowable number of shares, in our sole discretion, may be given the opportunity to increase their subscriptions up to the then applicable limit. The effect of this type of resolicitation will be an increase in the number of shares owned by subscribers who choose to increase their subscriptions. Our Board of Directors may, in its sole discretion, increase the maximum purchase limitations up to 9.99% of the shares issued in the conversion, provided that orders for shares exceeding 5% of the shares being issued shall not exceed, in the aggregate, 10% of the total issued. In the event of an increase in the total number of shares offered in the offering, due to an increase in the offering range of up to 15%, shares will be allocated in the following order of priority in accordance with the plan of conversion: (1) to fill the employee stock ownership plan's subscription for 2% of the total number of shares sold; 83 (2) in the event that there is an oversubscription at the Eligible Account Holder, Supplemental Eligible Account Holder or Other Member levels, to fill unfulfilled subscriptions of these subscribers according to their respective priorities; and (3) to fill unfulfilled subscriptions in the community offering, with preference given first to Citizens South Banking Corporation public stockholders as of July 31, 2002, and then to natural persons residing in the North Carolina Counties Gaston, Rowan, Iredell, Mecklenburg, Cabarrus, Cleveland and Lincoln and the South Carolina County of York. The term "associate" of a person means: (1) any corporation or organization, other than Citizens South Banking Corporation, Citizens South Bank or a majority-owned subsidiary of Citizens South Bank, of which the person is an officer, partner or 10% stockholder; (2) any trust or other estate in which the person has a substantial beneficial interest or serves as a director or in a similar fiduciary capacity; provided, however, it does not include any employee stock benefit plan in which the person has a substantial beneficial interest or serves as director or in a similar fiduciary capacity; and (3) any relative or spouse of the person, or any relative of the spouse, who either has the same home as the person or who is a director or officer of Citizens South Banking Corporation or Citizens South Bank. The term "acting in concert" means: (1) knowing participation in a joint activity or interdependent conscious parallel action towards a common goal whether or not pursuant to an express agreement; or (2) a combination or pooling of voting or other interests in the securities of an issuer for a common purpose pursuant to any contract, understanding, relationship, agreement or other arrangement, whether written or otherwise. A person or company which acts in concert with another person or company ("other party") shall also be deemed to be acting in concert with any person or company who is also acting in concert with that other party, except that any tax-qualified employee stock benefit plan will not be deemed to be acting in concert with its trustee or a person who serves in a similar capacity solely for the purpose of determining whether stock held by the trustee and stock held by the plan will be aggregated. Our directors are not treated as associates of each other solely because of their membership on our Board of Directors. We have the right to determine whether prospective purchasers are associates or acting in concert. For a further discussion of limitations on purchases of our stock at the time of conversion and thereafter, see "Certain Restrictions on Purchase or Transfer of Our Shares after Conversion" and "Restrictions on Acquisition of Citizens South Banking Corporation." Plan of Distribution; Selling Agent Compensation Offering materials have been distributed by mail to those with subscription rights at the last known address on our records as of the eligibility dates of the offering. Subscription rights expire whether or not eligible subscribers can be located. To assist in the marketing of the common stock, we have retained Keefe, Bruyette & Woods, Inc., which is a broker/dealer registered with the National Association of Securities Dealers, Inc. Keefe, Bruyette & Woods, Inc. will assist us in the offering by: (1) providing its employees to assist in staffing the Stock Information Center to assist our customers and internal stock purchasers and to assist in records management for orders of shares of common stock; 84 (2) targeting our sales efforts, including assisting in the preparation of marketing materials; (3) soliciting orders for common stock; and (4) assisting in soliciting proxies of our members and current stockholders. For these services, Keefe, Bruyette & Woods, Inc., will receive a management fee of $50,000 and a marketing fee equal to 1.35% of the dollar amount of common stock sold in the subscription and community offerings other than shares purchased by officers, directors and employees or their immediate families and any common stock purchased by our tax-qualified and non-qualified employee benefit plans, for which no fee need be paid. The marketing fee will be reduced by the $50,000 management fee, assuming the offering is completed successfully. In the event that Keefe, Bruyette & Woods, Inc. sells common stock through a group of broker-dealers in a syndicated community offering, it will be paid a fee not to exceed 5.5% of the dollar amount of total shares sold in the syndicated community offering. From this fee, Keefe, Bruyette & Woods, Inc. will pass on to selected broker-dealers who assist in the syndicated community offering an amount competitive with gross underwriting discounts charged at such time for comparable amounts of stock sold at a comparable price per share in a similar marketing environment. Keefe, Bruyette & Woods, Inc. will also be reimbursed for allocable expenses in an amount not to exceed $15,000, and for attorney's fees and expenses in an amount not to exceed $35,000. We have made an advance payment to Keefe, Bruyette & Woods, Inc. in the amount of $12,500. We will indemnify Keefe, Bruyette & Woods, Inc. against liabilities and expenses, including legal fees, incurred in connection with certain claims or litigation arising out of or based upon untrue statements or omissions contained in the offering materials for the common stock, including liabilities under the Securities Act of 1933. Some of our directors and executive officers may participate in the solicitation of offers to purchase common stock. These persons will be reimbursed for their reasonable out-of-pocket expenses incurred in connection with the solicitation. Other regular, full-time employees of Citizens South Bank may assist in the offering, but only in ministerial capacities, and may provide clerical work in effecting a sales transaction. No offers or sales may be made by tellers or at the teller counters. All sales activity will be conducted in a segregated or separately identifiable area of Citizens South Bank's main offices apart from the area accessible to the general public. Other questions of prospective purchasers will be directed to executive officers or registered representatives of Keefe, Bruyette & Woods, Inc. Our other employees have been instructed not to solicit offers to purchase common stock or provide advice regarding the purchase of common stock. We will rely on Rule 3a4-1 under the Securities Exchange Act of 1934, and sales of common stock will be conducted within the requirements of Rule 3a4-1, so as to permit officers, directors and employees to participate in the sale of common stock. None of our officers, directors or employees will be compensated in connection with their participation in the offering. Procedure for Purchasing Shares Expiration Date. The offering will terminate at 12:00 noon, North Carolina Time, on September 18, 2002, unless we extend it, with the approval of the Office of Thrift Supervision, if required. This extension may be approved by us, in our sole discretion, without further approval or additional notice to purchasers in the offering. Any extension of the offering beyond 45 days after the expiration date of the offering would require the Office of Thrift Supervision's approval, and potential purchasers would be given the right to increase, decrease or rescind their orders for common stock. If we have not sold the minimum number of shares offered in the offering by the expiration date or any extension thereof, we may terminate the offering and promptly refund all orders for common stock. If the number of shares offered is reduced below the minimum of the offering range, or increased above the adjusted maximum of the offering range, purchasers will be given an opportunity to increase, decrease or rescind their orders. To ensure that each purchaser receives a prospectus at least 48 hours before the expiration date of the offering in accordance with Rule 15c2-8 of the Securities Exchange Act of 1934, no prospectus will be mailed any later than five days prior to this date or hand delivered any later than two days prior to this date. Execution of an order form will confirm receipt of delivery in accordance with Rule 15c2-8. Order forms will be distributed only with a prospectus. Subscription funds will be maintained in a special escrow account at Citizens South Bank. 85 We reserve the right in our sole discretion to terminate the offering at any time and for any reason, in which case we will cancel any withdrawal orders and return all funds submitted, plus interest at Citizens South Bank's current passbook savings rate from the date of receipt. Use of Order Forms. In order to purchase shares of the common stock in the subscription offering and community offering, you must complete an order form and remit payment. Incomplete order forms or order forms that are not signed are not required to be accepted. We will not be required to accept orders submitted on photocopied or facsimiled stock order forms. All order forms must be received prior to 12:00 noon, North Carolina Time on September 18, 2002. We are not required to accept order forms that are not received by that time, are executed defectively or are received without full payment or without appropriate withdrawal instructions. We are not required to notify subscribers of incomplete or improperly executed order forms, and we have the right to waive or permit the correction of incomplete or improperly executed order forms. We do not represent, however, that we will do so and we have no affirmative duty to notify any prospective subscriber of any such defects. You may submit your order form and payment by mail using the return envelope provided, by bringing your order form to our stock information center, or by overnight delivery to the indicated address on the back of the order form. Order forms may be delivered in person to Citizens South Bank branches. Once tendered, an order form cannot be modified or revoked without our consent. We reserve the absolute right, in our sole discretion, to reject orders received in the community offering, in whole or in part, at the time of receipt or at any time prior to completion of the offering. If you are ordering shares, you must represent that you are purchasing shares for your own account and that you have no agreement or understanding with any person for the sale or transfer of the shares. Our interpretation of the terms and conditions of the plan of conversion and of the acceptability of the order forms will be final. By signing the order form, you will be acknowledging that the common stock is not a deposit or savings account that is federally insured or otherwise guaranteed by Citizens South Bank or the Federal Government, and that you received a copy of this prospectus. However, signing the order form will not result in you waiving your rights under the Securities Act of 1933 or the Securities Exchange Act of 1934. Payment for Shares. Payment for all shares will be required to accompany all completed order forms for the purchase to be valid. Payment for shares may be made by: (1) personal check, bank check or bank draft, made payable to Citizens South Banking Corporation; or (2) authorization of withdrawal from Citizens South Bank deposit accounts (except checking accounts) designated on the stock order form. Appropriate means for designating withdrawals from deposit accounts at Citizens South Bank are provided in the order forms. The funds designated must be available in the account(s) at the time the order form is received. A hold will be placed on these funds, making them unavailable to the depositor. Funds authorized for withdrawal will continue to earn interest within the account at the contract rate until the offering is completed, at which time the designated withdrawal will be made. Interest penalties for early withdrawal applicable to certificate accounts will not apply to withdrawals authorized for the purchase of shares of common stock; however, if a withdrawal results in a certificate account with a balance less than the applicable minimum balance requirement, the certificate will be cancelled at the time of withdrawal without penalty and the remaining balance will earn interest at the current passbook rate subsequent to the withdrawal. In the case of payments made by check or money order, these funds must be available in the account(s) and will be immediately cashed and placed in a segregated escrow account at Citizens South Bank and interest will be paid at the current passbook savings rate from the date payment is received until the offering is completed or terminated. Once we receive your executed order form, it may not be modified, amended or rescinded without our consent, unless the offering is not completed by the expiration date, in which event purchasers may be given the opportunity to increase, decrease or rescind their orders for a specified period of time. If you are interested in using your individual retirement account funds to purchase common stock, you must do so through a self-directed individual retirement account. Citizens South Bank, by law, cannot maintain self-directed individual retirement accounts. Therefore, if you wish to use your funds that are currently in a Citizens South Bank individual retirement account, you may not designate on the order form that you wish funds to be 86 withdrawn from the account for the purchase of common stock. The funds you wish to use for the purchase of common stock will have to be transferred to a brokerage account. There will be no early withdrawal or Internal Revenue Service interest penalties for these transfers. Depositors interested in using funds in an individual retirement account or any other retirement account to purchase common stock should contact the stock information center as soon as possible, preferably at least two weeks prior to the end of the offering period, because processing such transactions takes additional time, and whether such funds can be used may depend on limitations imposed by the institutions where such funds are currently held. We cannot guarantee that you will be able to use such funds. Citizens South Banking Corporation shall have the right, in its sole discretion, to permit institutional investors to submit irrevocable orders together with the legally binding commitment for payment and to thereafter pay for the shares of common stock for which they subscribe in the community offering at any time prior to 48 hours before the completion of the reorganization. This payment may be made under wire transfer. If our employee stock ownership plan purchases shares in the offering, it will not be required to pay for such shares until consummation of the offering, provided there is a loan commitment from an unrelated financial institution or Citizens South Banking Corporation to lend to the employee stock ownership plan the necessary amount to fund the purchase. Regulations prohibit Citizens South Bank from lending funds or extending credit to any persons to purchase common stock in the offering. Delivery of Stock Certificates. Certificates representing common stock issued in the offering and Citizens South Bank checks representing any applicable refund and/or interest paid on subscriptions made by check, money order or bank draft will be mailed to the persons entitled thereto at the certificate registration address noted on the order form, as soon as practicable following consummation of the offering and receipt of all necessary regulatory approvals. Any certificates returned as undeliverable will be held by the transfer agent until claimed by persons legally entitled thereto or otherwise disposed of in accordance with applicable law. Until certificates for the common stock are available and delivered to purchasers, purchasers may not be able to sell the shares of stock which they ordered, even though the common stock will have begun trading. Other Restrictions. Notwithstanding any other provision of the plan of conversion, no person is entitled to purchase any common stock to the extent the purchase would be illegal under any federal or state law or regulation, including state "blue sky" registrations, or would violate regulations or policies of the National Association of Securities Dealers, Inc., particularly those regarding free riding and withholding. We may ask for an acceptable legal opinion from any purchaser as to the legality of his or her purchase and we may refuse to honor any purchase order if an opinion is not timely furnished. Restrictions on Transfer of Subscription Rights and Shares Office of Thrift Supervision conversion regulations prohibit any person with subscription rights, including the Eligible Account Holders, Supplemental Eligible Account Holders and Other Members, from transferring or entering into any agreement or understanding to transfer the legal or beneficial ownership of the subscription rights issued under the plan of conversion or the shares of common stock to be issued upon their exercise. These rights may be exercised only by the person to whom they are granted and only for his or her account. Each person exercising subscription rights will be required to certify that he or she is purchasing shares solely for his or her own account and that he or she has no agreement or understanding regarding the sale or transfer of such shares. The regulations also prohibit any person from offering or making an announcement of an offer or intent to make an offer to purchase subscription rights or shares of common stock to be issued upon their exercise prior to completion of the offering. We will pursue any and all legal and equitable remedies in the event we become aware of the transfer of subscription rights, and we will not honor orders that we believe involve the transfer of subscription rights. 87 Stock Information Center If you have any questions regarding the offering, please call the stock information center, toll free, at (___) ___-____, from 9:00 a.m. to 5:00 p.m. North Carolina Time, Monday through Friday. The stock information center is located at______________________________________. Liquidation Rights In the unlikely event of a complete liquidation of Citizens South Banking Corporation prior to the conversion, all claims of creditors of Citizens South Banking Corporation, including those of depositors to the extent of their deposit balances, would be paid first. Thereafter, if there were any assets of Citizens South Banking Corporation remaining, these assets would be distributed to stockholders, including Citizens South Holdings, MHC. In the unlikely event that Citizens South Holdings, MHC and Citizens South Banking Corporation liquidated prior to the conversion, all claims of creditors would be paid first. Then, if there were any assets of Citizens South Holdings, MHC remaining, members of Citizens South Holdings, MHC would receive those remaining assets, pro rata, based upon the deposit balances in their deposit account in Citizens South Bank immediately prior to liquidation. In the unlikely event that Citizens South Bank were to liquidate after the conversion, all claims of creditors, including those of depositors, would be paid first, followed by distribution of the "liquidation account" to certain depositors, with any assets remaining thereafter distributed to Citizens South Banking Corporation as the holder of Citizens South Bank capital stock. Pursuant to the rules and regulations of the Office of Thrift Supervision, a post-conversion merger, consolidation, sale of bulk assets or similar combination or transaction with another insured savings institution would not be considered a liquidation and, in these types of transactions, the liquidation account would be assumed by the surviving institution. The plan of conversion provides for the establishment, upon the completion of the conversion, of a special "liquidation account" for the benefit of Eligible Account Holders and Supplemental Eligible Account Holders (as those terms are defined in the plan of conversion) in an amount equal to the greater of: (1) Citizens South Holdings, MHC's ownership interest in the retained earnings of Citizens South Banking Corporation as of the date of its latest balance sheet contained in this prospectus; or (2) the retained earnings of Citizens South Bank at the time that Citizens South Bank reorganized into Citizens South Holdings, MHC in 1998. The purpose of the liquidation account is to provide Eligible Account Holders and Supplemental Eligible Account Holders who maintain their deposit accounts with Citizens South Bank after the conversion with an interest in the unlikely event of the complete liquidation of Citizens South Bank after the conversion. Each Eligible Account Holder and Supplemental Eligible Account Holder that continues to maintain his or her deposit account at Citizens South Bank, would be entitled, on a complete liquidation of Citizens South Bank after the conversion, to an interest in the liquidation account prior to any payment to the stockholders of Citizens South Banking Corporation. Each Eligible Account Holder and Supplemental Eligible Account Holder would have an initial interest in the liquidation account for each deposit account, including savings accounts, transaction accounts such as negotiable order of withdrawal accounts, money market deposit accounts, and certificates of deposit, with a balance of $50 or more held in Citizens South Bank on March 31, 2001 or June 30, 2002. Each Eligible Account Holder and Supplemental Eligible Account Holder would have a pro rata interest in the total liquidation account for each such deposit account, based on the proportion that the balance of each such deposit account on March 31, 2001 or June 30, 2002 bears to the balance of all deposit accounts in Citizens South Bank on such dates. If, however, on any December 31 annual closing date commencing after the effective date of the conversion, the amount in any such deposit account is less than the amount in the deposit account on March 31, 2001 or June 30, 2002 or any other annual closing date, then the interest in the liquidation account relating to such deposit account would be reduced from time to time by the proportion of any such reduction, and such interest will cease to exist if such deposit account is closed. In addition, no interest in the liquidation account would ever be increased despite any subsequent increase in the related deposit account. Payment pursuant to liquidation rights of Eligible Account Holders and Supplemental Eligible Account Holders would be separate and apart from the payment of any insured deposit accounts to such depositor. Any assets remaining after the above liquidation rights 88 of Eligible Account Holders and Supplemental Eligible Account Holders are satisfied would be distributed to Citizens South Banking Corporation as the sole stockholder of Citizens South Bank. Tax Aspects Consummation of the conversion is expressly conditioned upon the prior receipt of an opinion of counsel or tax advisor with respect to federal and state income taxation that indicates that the conversion will not be a taxable transaction to Citizens South Holdings, MHC, Citizens South Banking Corporation, Citizens South Bank, Eligible Account Holders, Supplemental Eligible Account Holders, and other members of Citizens South Holdings, MHC. Unlike private letter rulings, opinions of counsel or tax advisors are not binding on the Internal Revenue Service or any state taxing authority, and such authorities may disagree with such opinions. In the event of such disagreement, there can be no assurance that Citizens South Banking Corporation or Citizens South Bank would prevail in a judicial proceeding. Citizens South Holdings, MHC and Citizens South Banking Corporation have received an opinion of counsel, Luse Gorman Pomerenk & Schick, P.C., regarding the federal income tax consequences of the conversion which includes the following: 1. The merger of Citizens South Banking Corporation with and into Citizens South Bank qualifies as a tax-free reorganization within the meaning of Section 368(a)(1)(A) of the Code. 2. The merger of Citizens South Holdings, MHC with and into Citizens South Bank qualifies as a tax-free reorganization within the meaning of Section 368(a)(1)(A) of the Code. 3. The exchange of Eligible Account Holders' and Supplemental Account Holders' interests in Citizens South Holdings, MHC for interests in a liquidation account established in Citizens South Bank will satisfy the continuity of interest requirement of Section 1.368-1(b) of the Federal Income Tax Regulations. 4. Citizens South Holdings, MHC will not recognize any gain or loss on the transfer of its assets to Citizens South Bank in exchange for an interest in a liquidation account established in Citizens South Bank for the benefit of Eligible Account Holders and Supplemental Account Holders who remain depositors of Citizens South Bank. 5. No gain or loss will be recognized by Citizens South Bank upon the receipt of the assets of Citizens South Holdings, MHC in exchange for the transfer to the Eligible Account Holders and Supplemental Account Holders of an interest in the liquidation account in Citizens South Bank. 6. Eligible Account Holders and Supplemental Account Holders will recognize no gain or loss upon the receipt of an interest in the liquidation account in Citizens South Bank in exchange for their interests in Citizens South Holdings, MHC. 7. Current stockholders of Citizens South Banking Corporation will not recognize any gain or loss upon their exchange of Citizens South Banking Corporation common stock solely for new shares of Citizens South Banking Corporation common stock. 8. Cash received by any current stockholder of Citizens South Banking Corporation in lieu of a fractional share interest in new shares of Citizens South Banking Corporation common stock will be treated as having been received as a distribution in full payment in exchange for a fractional share interest of new Citizens South Banking Corporation common stock, which such stockholder would otherwise be entitled to receive, and will qualify as capital gain or loss, assuming common stock of Citizens South Banking Corporation surrendered in exchange therefor was held as a capital asset by such stockholder at the effective time of the conversion. 89 9. Each stockholder's aggregate basis in new shares of Citizens South Banking Corporation common stock received in the exchange will be the same as the aggregate basis of Citizens South Banking Corporation common stock surrendered in exchange therefor. 10. Each stockholder's holding period in his or her Citizens South Banking Corporation common stock received in the exchange will include the period during which Citizens South Banking Corporation common stock surrendered was held, provided that the Citizens South Banking Corporation common stock surrendered is a capital asset in the hands of the stockholder on the date of the exchange. 11. No gain or loss will be recognized by Eligible Account Holders, Supplemental Eligible Account Holders or other members upon distribution to them of subscription rights to purchase shares of Citizens South Banking Corporation common stock, provided that the amount to be paid for Citizens South Banking Corporation common stock is equal to the fair market value of Citizens South Banking Corporation common stock. 12. No gain or loss will be recognized by Citizens South Banking Corporation on the receipt of money in exchange for Citizens South Banking Corporation common stock sold in the offering. In the view of RP Financial, LC, which view is not binding on the Internal Revenue Service, the subscription rights do not have any value, based on the fact that these rights are acquired by the recipients without cost, are nontransferable and of short duration, and afford the recipients the right only to purchase the common stock at a price equal to its estimated fair market value, which will be the same price as the subscription price for the unsubscribed shares of common stock. If the subscription rights granted to Eligible Account Holders and Supplemental Eligible Account Holders are deemed to have an ascertainable value, receipt of these rights could result in taxable gain to those Eligible Account Holders and Supplemental Eligible Account Holders who exercise the subscription rights in an amount equal to the ascertainable value, and Citizens South Banking Corporation could recognize gain on a distribution. Eligible Account Holders and Supplemental Eligible Account Holders are encouraged to consult with their own tax advisors as to the tax consequences in the event that subscription rights are deemed to have an ascertainable value. Unlike private rulings, an opinion of RP Financial, LC is not binding on the Internal Revenue Service and the Internal Revenue Service could disagree with the conclusions reached therein. The federal tax opinion has been filed with the Securities and Exchange Commission as an exhibit to Citizens South Banking Corporation's registration statement. An opinion regarding the North Carolina state income tax consequences consistent with the federal tax opinion has been issued by Cherry Bekaert & Holland, L.L.P., tax advisors to Citizens South Holdings, MHC and Citizens South Banking Corporation. Certain Restrictions on Purchase or Transfer of Our Shares after Conversion All shares purchased in the offering by a director or an executive officer of Citizens South Bank generally may not be sold for a period of one year following the conversion, except in the event of the death of the director or executive officer. Each certificate for restricted shares will bear a legend giving notice of this restriction on transfer, and instructions will be issued to the effect that any transfer within this time period of any certificate or record ownership of the shares other than as provided above is a violation of the restriction. Any shares of common stock issued at a later date as a stock dividend, stock split, or otherwise, with respect to the restricted stock will be similarly restricted. The directors and executive officers of Citizens South Bank also will be restricted by the insider trading rules promulgated pursuant to the Securities Exchange Act of 1934. Purchases of shares of our common stock by any of our directors, executive officers and their associates, during the three-year period following the conversion may be made only through a broker or dealer registered with the Securities and Exchange Commission, except with the prior written approval of the Office of Thrift Supervision. This restriction does not apply, however, to negotiated transactions involving more than 1% of our outstanding common stock or to purchases of our common stock by our stock option plan or any of our tax-qualified employee stock benefit plans or nontax-qualified employee stock benefit plans, including any recognition and retention plans or restricted stock plans. 90 Office of Thrift Supervision regulations prohibit Citizens South Banking Corporation from repurchasing its common stock during the first year following conversion unless compelling business reasons exist for such repurchases. After one year, the Office of Thrift Supervision does not impose any repurchase restrictions. COMPARISON OF STOCKHOLDERS' RIGHTS General. As a result of the conversion, our existing Citizens South Banking Corporation stockholders will become stockholders of Citizens South Banking Corporation, a Delaware corporation. There are certain differences in stockholder rights arising from distinctions between Citizens South Banking Corporation's federal stock charter and bylaws and Citizens South Banking Corporation's Delaware certificate of incorporation and bylaws, and from distinctions between laws applicable to Delaware and federally chartered corporations. This discussion is not intended to be a complete statement of the differences affecting the rights of stockholders, but rather summarizes the material differences and similarities affecting the rights of stockholders. This discussion is qualified in its entirety by reference to the certificate of incorporation and bylaws of Citizens South Banking Corporation and the Delaware General Corporation Law. See "Additional Information" for procedures for obtaining a copy of Citizens South Banking Corporation's certificate of incorporation and bylaws. Authorized Capital Stock. Our authorized capital stock currently consists of 20,000,000 shares of common stock, par value $1.00 per share, and 10,000,000 shares of preferred stock. After the conversion, our authorized capital stock as a Delaware corporation will consist of 20,000,000 shares of common stock, $0.01 par value per share, and 1,000,000 shares of preferred stock, par value $0.01 per share. We authorized more capital stock than that which will be issued in the conversion in order to provide our Board of Directors with flexibility to effect, among other transactions, financings, acquisitions, stock dividends, stock splits and stock option grants. However, these additional authorized shares may also be used by our Board of Directors consistent with its fiduciary duty to deter future attempts to gain control of Citizens South Banking Corporation. Our Board of Directors also has sole authority to determine the terms of any one or more series of preferred stock, including voting rights, conversion rates and liquidation preferences. As a result of the ability to fix voting rights for a series of preferred stock, our Board has the power, to the extent consistent with its fiduciary duty, to issue a series of preferred stock to persons friendly to management in order to attempt to block a hostile tender offer, merger or other transaction by which a third party seeks control, and thereby assist management to retain its position. We currently have no plans for the issuance of additional shares, other than the issuance of additional shares through our stock benefit plans. Issuance of Capital Stock. Pursuant to applicable laws and regulations, Citizens South Holdings, MHC is required to own not less than a majority of the outstanding Citizens South Banking Corporation common stock. There will be no such restriction applicable to Citizens South Banking Corporation following consummation of the conversion. Citizens South Banking Corporation's Delaware certificate of incorporation does not contain restrictions on the issuance of shares of capital stock to directors, officers or controlling persons, whereas Citizens South Banking Corporation's federal stock charter restricts such issuances to general public offerings, or to directors for qualifying shares, unless the share issuance or the plan under which they would be issued has been approved by a majority of the total votes eligible to be cast at a legal stockholders' meeting. Thus, stock related compensation plans, such as stock option plans and recognition and retention plans, may be adopted by Citizens South Banking Corporation without stockholder approval and shares of Citizens South Banking Corporation capital stock may be issued directly to directors or officers without stockholder approval. The bylaws of the National Association of Securities Dealers, Inc., however, generally require corporations with securities that are quoted on the Nasdaq National Market System to obtain stockholder approval of most stock compensation plans for directors, officers and key employees of the corporation. Moreover, although generally not required, stockholder approval of stock-related compensation plans may be sought in certain instances in order to qualify such plans for favorable federal income tax and securities law treatment under current laws and regulations. Voting Rights. Neither Citizens South Banking Corporation's federal stock charter or bylaws nor Citizens South Banking Corporation's Delaware certificate of incorporation or bylaws provide for cumulative voting for the election of directors. For additional information regarding voting rights, see "--Limitations on Voting Rights of Greater-than-10% Stockholders" below. 91 Payment of Dividends. The ability of Citizens South Banking Corporation to pay dividends on its capital stock is restricted by Office of Thrift Supervision regulations and by federal income tax considerations related to savings banks such as Citizens South Bank. See "Supervision and Regulation--Federal Banking Regulation--Capital Distributions." Although Citizens South Banking Corporation is not subject to these restrictions as a Delaware corporation, such restrictions will indirectly affect Citizens South Banking Corporation because dividends from Citizens South Bank will be a primary source of funds of Citizens South Banking Corporation for the payment of dividends to stockholders of Citizens South Banking Corporation. Certain restrictions generally imposed on Delaware corporations may also have an impact on Citizens South Banking Corporation's ability to pay dividends. Delaware law generally provides that Citizens South Banking Corporation is limited to paying dividends in an amount equal to the excess of its net assets (total assets minus total liabilities) over its statutory capital or, if no such excess exists, equal to its net profits for the current year and/or the immediately preceding fiscal year. Board of Directors. Citizens South Banking Corporation's federal stock charter and bylaws and Citizens South Banking Corporation's Delaware certificate of incorporation and bylaws each require the Board of Directors to be divided into three classes and that the members of each class shall be elected for a term of three years and until their successors are elected and qualified, with one class being elected annually. Under Citizens South Banking Corporation's federal bylaws, any vacancies on the Board of Directors of Citizens South Banking Corporation may be filled by the affirmative vote of a majority of the remaining directors although less than a quorum of the Board of Directors. Persons elected by the directors of Citizens South Banking Corporation to fill vacancies may only serve until the next annual meeting of stockholders. Under Citizens South Banking Corporation's Delaware certificate of incorporation, any vacancy occurring in the Board of Directors of Citizens South Banking Corporation, including any vacancy created by reason of an increase in the number of directors, may be filled by the remaining directors, and any director so chosen shall hold office for the remainder of the term to which the director has been elected and until his or her successor is elected and qualified. Under Citizens South Banking Corporation's federal bylaws, any director may be removed for cause by the holders of a majority of the outstanding voting shares. Citizens South Banking Corporation's Delaware certificate of incorporation provides that any director may be removed for cause by the holders of at least 80% of the outstanding voting shares of Citizens South Banking Corporation. Limitations on Liability. The federal stock charter and bylaws of Citizens South Banking Corporation do not limit the personal liability of directors. Citizens South Banking Corporation's Delaware certificate of incorporation provides that the directors of Citizens South Banking Corporation will not be personally liable for monetary damages to Citizens South Banking Corporation for certain actions as directors, except for actions or omissions not in good faith or that involve intentional misconduct or a knowing violation of law by the director, the authorization of illegal distributions or receipt of an improper personal benefit from their positions as directors. This provision might, in certain instances, discourage or deter shareholders or management from bringing a lawsuit against directors for a breach of their duties even though such an action, if successful, might have benefited Citizens South Banking Corporation. Indemnification of Directors, Officers, Employees and Agents. Citizens South Banking Corporation's federal stock charter and bylaws do not contain any provision relating to indemnification of directors and officers of Citizens South Banking Corporation Under current Office of Thrift Supervision regulations, however, Citizens South Banking Corporation shall indemnify its directors, officers and employees for any costs incurred in connection with any litigation involving such person's activities as a director, officer or employee if such person obtains a final judgment on the merits in his or her favor. In addition, indemnification is permitted in the case of a settlement, a final judgment against such person or final judgment other than on the merits, if a majority of disinterested directors determines that such person was acting in good faith within the scope of his or her employment as he or she could reasonably have perceived it under the circumstances and for a purpose he or she could reasonably have believed under the circumstances was in the best interests of Citizens South Banking Corporation or its stockholders. Citizens South Banking Corporation also is permitted to pay ongoing expenses incurred by a director, officer or employee if a majority of disinterested directors concludes that such person may 92 ultimately be entitled to indemnification. Before making any indemnification payment, Citizens South Banking Corporation is required to notify the Office of Thrift Supervision of its intention and such payment cannot be made if the Office of Thrift Supervision objects to such payment. The officers, directors, agents and employees of Citizens South Banking Corporation are indemnified with respect to certain actions pursuant to Citizens South Banking Corporation's Delaware certificate of incorporation, which complies with Delaware law regarding indemnification. Delaware law allows Citizens South Banking Corporation to indemnify the aforementioned persons for expenses, liabilities, settlements, judgments and fines in suits in which such person has been made a party by reason of the fact that he or she is or was a director or officer of Citizens South Banking Corporation. No such indemnification may be given if the acts or omissions of the person are adjudged to be in violation of law, if such person is liable to the corporation for an unlawful distribution, or if such person personally received a benefit to which he or she was not entitled. The right to indemnification includes the right to be paid the expenses incurred in advance of final disposition of a proceeding. Special Meetings of Stockholders. Citizens South Banking Corporation's federal bylaws provide that special meetings of Citizens South Banking Corporation's stockholders may be called by the Chairman, the President, a majority of the Board of Directors or the holders of not less than one-tenth of the outstanding capital stock of Citizens South Banking Corporation entitled to vote at the meeting. Citizens South Banking Corporation's Delaware certificate of incorporation provides that special meetings of the stockholders of Citizens South Banking Corporation may be called only by a majority vote of the total authorized directors. Stockholder Nominations and Proposals. Citizens South Banking Corporation's federal bylaws generally provide that stockholders may submit nominations for election of directors at an annual meeting of stockholders and any new business to be taken up at such a meeting by filing the proposal in writing with Citizens South Banking Corporation at least five days before the date of any such meeting. Citizens South Banking Corporation's Delaware bylaws generally provide that any stockholder desiring to make a nomination for the election of directors or a proposal for new business at a meeting of stockholders must submit written notice to Citizens South Banking Corporation 90 days prior to the anniversary date of the mailing of proxy materials by Citizens South Banking Corporation in connection with the immediately preceding annual meeting of stockholders. However, if less than 100 days notice or prior disclosure of the date of the meeting is given, stockholders must submit such written notice no later than the tenth day following the date on which notice of the meeting is mailed to stockholders or such public disclosure was made. Failure to comply with these advance notice requirements will preclude such nominations or new business from being considered at the meeting. Management believes that it is in the best interests of Citizens South Banking Corporation and its stockholders to provide sufficient time to enable management to disclose to stockholders information about a dissident slate of nominations for directors. This advance notice requirement may also give management time to solicit its own proxies in an attempt to defeat any dissident slate of nominations, should management determine that doing so is in the best interests of stockholders generally. Similarly, adequate advance notice of stockholder proposals will give management time to study such proposals and to determine whether to recommend to the stockholders that such proposals be adopted. In certain instances, such provisions could make it more difficult to oppose management's nominees or proposals, even if stockholders believe such nominees or proposals are in their best interests. Stockholder Action Without a Meeting. The federal bylaws of Citizens South Banking Corporation provide that any action to be taken or which may be taken at any annual or special meeting of stockholders may be taken if a consent in writing, setting forth the actions so taken, is given by the holders of all outstanding shares entitled to vote. Citizens South Banking Corporation's Delaware certificate of incorporation specifically denies the authority of stockholders to act without a meeting. Stockholder's Right to Examine Books and Records. A federal regulation, which is applicable to Citizens South Banking Corporation, provides that stockholders may inspect and copy specified books and records of a federally chartered savings institution after proper written notice for a proper purpose. Delaware law similarly provides that a stockholder may inspect books and records upon written demand stating the purpose of the inspection, if such purpose is reasonably related to such person's interest as a stockholder. 93 Limitations on Voting Rights of Greater-than-10% Stockholders. Citizens South Banking Corporation's Delaware certificate of incorporation provides that no record or beneficial owner, directly or indirectly, of more than 10% of the outstanding shares of common stock will be permitted to vote any shares in excess of such 10% limit. Mergers, Consolidations and Sales of Assets. A federal regulation requires the approval of two-thirds of the Board of Directors of Citizens South Banking Corporation and the holders of two-thirds of the outstanding stock of Citizens South Banking Corporation entitled to vote thereon for mergers, consolidations and sales of all or substantially all of Citizens South Banking Corporation's assets. Such regulation permits Citizens South Banking Corporation to merge with another corporation without obtaining the approval of its stockholders if: (1) it does not involve an interim savings institution; (2) Citizens South Banking Corporation's federal stock charter is not changed; (3) each share of Citizens South Banking Corporation's stock outstanding immediately prior to the effective date of the transaction will be an identical outstanding share or a treasury share of Citizens South Banking Corporation after such effective date; and (4) either: (a) no shares of voting stock of Citizens South Banking Corporation and no securities convertible into such stock are to be issued or delivered under the plan of combination; or (b) the authorized unissued shares or the treasury shares of voting stock of Citizens South Banking Corporation to be issued or delivered under the plan of combination, plus those initially issuable upon conversion of any securities to be issued or delivered under such plan, do not exceed 15% of the total shares of voting stock of Citizens South Banking Corporation outstanding immediately prior to the effective date of the transaction. Citizens South Banking Corporation's Delaware certificate of incorporation requires the approval of the holders of at least 80% of Citizens South Banking Corporation's outstanding shares of voting stock to approve certain "Business Combinations" involving an "Interested Stockholder" except where (i) the proposed transaction has been approved by two-thirds of the members of the Board of Directors who are unaffiliated with the Interested Stockholder and who were directors prior to the time when the Interested Stockholder became an Interested Stockholder, or (ii) certain "fair price" provisions are complied with. The term "Interested Stockholder" includes any individual, corporation, partnership or other entity, other than Citizens South Banking Corporation or its subsidiary, which owns beneficially or controls, directly or indirectly, 10% or more of the outstanding shares of voting stock of Citizens South Banking Corporation or an affiliate of such person or entity. This provision of the certificate of incorporation applies to any "Business Combination," which is defined to include, among other things: (1) any merger or consolidation of Citizens South Banking Corporation with or into any Interested Stockholder; (2) any sale, lease, exchange, mortgage, transfer, or other disposition of 25% or more of the assets of Citizens South Banking Corporation and its subsidiaries to an Interested Stockholder; (3) the issuance or transfer of any securities of Citizens South Banking Corporation or a subsidiary of Citizens South Banking Corporation to an Interested Stockholder having a value exceeding 25% of the combined fair market value of the outstanding securities of Citizens South Banking Corporation; (4) the adoption of any plan or proposal for the liquidation or dissolution of Citizens South Banking Corporation proposed by or on behalf of an Interested Stockholder or any Affiliate of an Interested Stockholder; or (5) any reclassification of securities, any recapitalization, or any merger with a subsidiary or other transaction that has the effect of increasing an Interested Stockholder's proportional share of any class of securities of Citizens South Banking Corporation. 94 Under Delaware law, absent this provision, business combinations, including mergers, consolidations and sales of substantially all of the assets of a corporation must, subject to certain exceptions, be approved by the vote of the holders of a majority of the outstanding shares of common stock of Citizens South Banking Corporation and any other affected class of stock. One exception under Delaware law to the majority approval requirement applies to stockholders owning 15% or more of the common stock of a corporation for a period of less than three years. Such 15% stockholder, in order to obtain approval of a business combination, must obtain the approval of two-thirds of the outstanding stock, excluding the stock owned by such 15% stockholder, or satisfy other requirements under Delaware law relating to board of director approval of his or her acquisition of the shares of Citizens South Banking Corporation The increased stockholder vote required to approve a business combination may have the effect of preventing mergers and other business combinations which a majority of stockholders deem desirable and placing the power to prevent such a merger or combination in the hands of a minority of stockholders. Citizens South Banking Corporation's Delaware certificate of incorporation provides that the Citizens South Banking Corporation's Board of Directors may consider certain factors in addition to the amount of consideration to be paid when evaluating certain business combinations or a tender or exchange offer. These additional factors include the social and economic effects of the transaction on its customers and employees and the communities served by Citizens South Banking Corporation. Dissenters' Rights of Appraisal. Office of Thrift Supervision regulations generally provide that a stockholder of a federally chartered savings institution that engages in a merger, consolidation or sale of all or substantially all of its assets shall have the right to demand from such institution payment of the fair or appraised value of his or her stock in the institution, subject to specified procedural requirements. However, if the federally chartered savings institution's stock is listed on a national securities exchange or quoted on the Nasdaq Stock Market, stockholders are not entitled to dissenters' rights in connection with a merger if the stockholders are required to accept cash or shares of stock which will be listed on a national securities exchange or quoted on the Nasdaq Stock Market, or any combination thereof. Under Delaware law, except for cash merger transactions, shareholders of Citizens South Banking Corporation generally will not have dissenters' appraisal rights in connection with a plan of merger or consolidation to which Citizens South Banking Corporation is a party because the common stock is expected to be listed on the Nasdaq National Market. Amendment of Governing Instruments. No amendment of Citizens South Banking Corporation's federal stock charter may be made unless it is first proposed by the Board of Directors of Citizens South Banking Corporation, then preliminarily approved by the Office of Thrift Supervision, and thereafter approved by the holders of a majority of the total votes eligible to be cast at a legal meeting. Citizens South Banking Corporation's Delaware certificate of incorporation may be amended by the vote of the holders of a majority of the outstanding shares of Citizens South Banking Corporation common stock, except that the provisions of the certificate of incorporation governing the calling of meetings of stockholders and the prohibition of action by written consent of stockholders, stockholder nominations and proposals, limitations on voting rights of 10% stockholders, the number and staggered terms of directors, vacancies on the Board of Directors and removal of directors, approval of certain business combinations, indemnification of officers and directors, and the manner of amending the certificate of incorporation and bylaws, may not be repealed, altered, amended or rescinded except by the vote of the holders of at least 80% of the outstanding shares of Citizens South Banking Corporation. The federal bylaws of Citizens South Banking Corporation may be amended by a majority vote of the full Board of Directors of Citizens South Banking Corporation or by a majority vote of the votes cast by the stockholders of Citizens South Banking Corporation at any legal meeting. Citizens South Banking Corporation's Delaware bylaws may only be amended by a majority vote of the Board of Directors of Citizens South Banking Corporation or by the holders of at least 80% of the outstanding stock of Citizens South Banking Corporation. Residency Requirement for Directors. Citizens South Banking Corporation's Delaware bylaws provide that only persons who reside or work in a county in which Citizens South Bank maintains an office or in a county contiguous to a county in which Citizens South Bank maintains an office will be qualified to be appointed or elected to the Board of Directors of Citizens South Banking Corporation. Citizens South Banking Corporation's federal bylaws have no similar provision. 95 Purpose and Anti-Takeover Effects of Citizens South Banking Corporation's Delaware Certificate of Incorporation and Bylaws. Our Board of Directors believes that the provisions described above are prudent and will reduce our vulnerability to takeover attempts and certain other transactions that have not been negotiated with and approved by our Board of Directors. These provisions will also assist us in the orderly deployment of the conversion proceeds into productive assets during the initial period after the conversion. Our Board of Directors believes these provisions are in the best interests of Citizens South Banking Corporation and its stockholders. Our Board of Directors believes that it will be in the best position to determine the true value of Citizens South Banking Corporation and to negotiate more effectively for what may be in the best interests of its stockholders. Accordingly, our Board of Directors believes that it is in the best interests of Citizens South Banking Corporation and its stockholders to encourage potential acquirers to negotiate directly with the Board of Directors of Citizens South Banking Corporation and that these provisions will encourage such negotiations and discourage hostile takeover attempts. It is also the view of our Board of Directors that these provisions should not discourage persons from proposing a merger or other transaction at a price reflective of the true value of Citizens South Banking Corporation and that is in the best interests of all stockholders. Takeover attempts that have not been negotiated with and approved by our Board of Directors present the risk of a takeover on terms that may be less favorable than might otherwise be available. A transaction that is negotiated and approved by our Board of Directors, on the other hand, can be carefully planned and undertaken at an opportune time in order to obtain maximum value of Citizens South Banking Corporation for our stockholders, with due consideration given to matters such as the management and business of the acquiring corporation and maximum strategic development of Citizens South Banking Corporation's assets. Although a tender offer or other takeover attempt may be made at a price substantially above the current market price, such offers are sometimes made for less than all of the outstanding shares of a target company. As a result, stockholders may be presented with the alternative of partially liquidating their investment at a time that may be disadvantageous, or retaining their investment in an enterprise that is under different management and whose objectives may not be similar to those of the remaining stockholders. Despite our belief as to the benefits to stockholders of these provisions of Citizens South Banking Corporation's Delaware certificate of incorporation and bylaws, these provisions may also have the effect of discouraging a future takeover attempt that would not be approved by our Board, but pursuant to which stockholders may receive a substantial premium for their shares over then current market prices. As a result, stockholders who might desire to participate in such a transaction may not have any opportunity to do so. Such provisions will also make it more difficult to remove our Board of Directors and management. Our Board of Directors, however, has concluded that the potential benefits outweigh the possible disadvantages. Following the conversion, pursuant to applicable law and, if required, following the approval by stockholders, we may adopt additional anti-takeover charter provisions or other devices regarding the acquisition of our equity securities that would be permitted for a Delaware business corporation. The cumulative effect of the restriction on acquisition of Citizens South Banking Corporation contained in the Delaware certificate of incorporation and bylaws of Citizens South Banking Corporation and in Delaware law may be to discourage potential takeover attempts and perpetuate incumbent management, even though certain stockholders of Citizens South Banking Corporation may deem a potential acquisition to be in their best interests, or deem existing management not to be acting in their best interests. RESTRICTIONS ON ACQUISITION OF CITIZENS SOUTH BANKING CORPORATION The following discussion is a summary of certain provisions of federal law and regulations and corporate law relating to stock ownership and transfers, the Board of Directors and business combinations, all of which may be deemed to have "anti-takeover" effects. The description of these provisions is necessarily general and reference should be made to the actual law and regulations. 96 Conversion Regulations Office of Thrift Supervision regulations prohibit any person from making an offer, announcing an intent to make an offer or participating in any other arrangement to purchase stock or acquiring stock or subscription rights in a converting institution or its holding company from another person prior to completion of its conversion. Further, without the prior written approval of the Office of Thrift Supervision, no person may make such an offer or announcement of an offer to purchase shares or actually acquire shares in the converting institution or its holding company for a period of three years from the date of the completion of the conversion if, upon the completion of such offer, announcement or acquisition, that person would become the beneficial owner of more than 10% of the outstanding stock of the institution or its holding company. The Office of Thrift Supervision has defined "person" to include any individual, group acting in concert, corporation, partnership, association, joint stock company, trust, unincorporated organization or similar company, a syndicate or any other group formed for the purpose of acquiring, holding or disposing of securities of an insured institution. However, offers made exclusively to an bank or its holding company, or an underwriter or member of a selling group acting on the converting institution's or its holding company's behalf for resale to the general public are excepted. The regulation also provides civil penalties for willful violation or assistance in any such violation of the regulation by any person connected with the management of the converting institution or its holding company or who controls more than 10% of the outstanding shares or voting rights of a converted institution or its holding company. Change of Control Regulations Under the Change in Bank Control Act, no person may acquire control of an insured federal savings bank or its parent holding company unless the Office of Thrift Supervision has been given 60 days' prior written notice and has not issued a notice disapproving the proposed acquisition. In addition, Office of Thrift Supervision regulations provide that no company may acquire control of a savings bank without the prior approval of the Office of Thrift Supervision. Any company that acquires such control becomes a "savings and loan holding company" subject to registration, examination and regulation by the Office of Thrift Supervision. Control, as defined under federal law, means ownership, control of or holding irrevocable proxies representing more than 25% of any class of voting stock, control in any manner of the election of a majority of the savings bank's directors, or a determination by the Office of Thrift Supervision that the acquiror has the power to direct, or directly or indirectly to exercise a controlling influence over, the management or policies of the institution. Acquisition of more than 10% of any class of a savings bank's voting stock, if the acquiror is also subject to any one of eight "control factors," constitutes a rebuttable determination of control under the regulations. Such control factors include the acquiror being one of the two largest stockholders. The determination of control may be rebutted by submission to the Office of Thrift Supervision, prior to the acquisition of stock or the occurrence of any other circumstances giving rise to such determination, of a statement setting forth facts and circumstances which would support a finding that no control relationship will exist and containing certain undertakings. The regulations provide that persons or companies which acquire beneficial ownership exceeding 10% or more of any class of a savings bank's stock who do not intend to participate in or seek to exercise control over a savings bank's management or policies may qualify for a safe harbor by filing with the Office of Thrift Supervision a certification form that states, among other things, that the holder is not in control of such institution, is not subject to a rebuttable determination of control and will take no action which would result in a determination or rebuttable determination of control without prior notice to or approval of the Office of Thrift Supervision, as applicable. There are also rebuttable presumptions in the regulations concerning whether a group "acting in concert" exists, including presumed action in concert among members of an "immediate family." The Office of Thrift Supervision may prohibit an acquisition of control if it finds, among other things, that: (1) the acquisition would result in a monopoly or substantially lessen competition; (2) the financial condition of the acquiring person might jeopardize the financial stability of the institution; or (3) the competence, experience or integrity of the acquiring person indicates that it would not be in the interest of the depositors or the public to permit the acquisition of control by such person. 97 DESCRIPTION OF CAPITAL STOCK OF CITIZENS SOUTH BANKING CORPORATION FOLLOWING THE CONVERSION General At the effective date, Citizens South Banking Corporation will be authorized to issue 20,000,000 shares of common stock having a par value of $0.01 per share and 1,000,000 shares of preferred stock. Citizens South Banking Corporation currently expects to issue in the offering up to 4,600,000 shares of common stock, subject to adjustment, and up to 3,773,020 shares, subject to adjustment, in exchange for the publicly held shares of Citizens South Banking Corporation. Citizens South Banking Corporation will not issue shares of preferred stock in the conversion. Each share of Citizens South Banking Corporation common stock will have the same relative rights as, and will be identical in all respects with, each other share of common stock. Upon payment of the subscription price for the common stock, in accordance with the plan of conversion, all of the common stock will be duly authorized, fully paid and nonassessable. The common stock of Citizens South Banking Corporation will represent nonwithdrawable capital, will not be an account of an insurable type, and will not be insured by the Federal Deposit Insurance Corporation or any other government agency. Common Stock Dividends. Citizens South Banking Corporation may pay dividends out of statutory surplus or from net earnings if, as and when declared by its Board of Directors. The payment of dividends by Citizens South Banking Corporation is subject to limitations that are imposed by law and applicable regulation. The holders of common stock of Citizens South Banking Corporation will be entitled to receive and share equally in dividends as may be declared by the Board of Directors of Citizens South Banking Corporation out of funds legally available therefor. If Citizens South Banking Corporation issues preferred stock, the holders thereof may have a priority over the holders of the common stock with respect to dividends. Voting Rights. When the conversion is completed, the holders of common stock of Citizens South Banking Corporation will have exclusive voting rights in Citizens South Banking Corporation. They will elect Citizens South Banking Corporation's Board of Directors and act on other matters as are required to be presented to them under Delaware law or as are otherwise presented to them by the Board of Directors. Generally, each holder of common stock will be entitled to one vote per share and will not have any right to cumulate votes in the election of directors. If Citizens South Banking Corporation issues preferred stock, holders of the preferred stock may also possess voting rights. Certain matters require an 80% stockholder vote. As a federal stock savings bank, corporate powers and control of Citizens South Bank are vested in its Board of Directors, who elect the officers of Citizens South Bank and who fill any vacancies on the Board of Directors. Voting rights of Citizens South Bank are vested exclusively in the owners of the shares of capital stock of Citizens South Bank, which will be Citizens South Banking Corporation, and voted at the direction of Citizens South Banking Corporation's Board of Directors. Consequently, the holders of the common stock of Citizens South Banking Corporation will not have direct control of Citizens South Bank. Liquidation. In the event of any liquidation, dissolution or winding up of Citizens South Bank, Citizens South Banking Corporation, as the holder of 100% of Citizens South Bank's capital stock, would be entitled to receive, after payment or provision for payment of all debts and liabilities of Citizens South Bank, including all deposit accounts and accrued interest thereon, and after distribution of the balance in the special liquidation account to Eligible Account Holders and Supplemental Eligible Account Holders, all assets of Citizens South Bank available for distribution. In the event of liquidation, dissolution or winding up of Citizens South Banking Corporation, the holders of its common stock would be entitled to receive, after payment or provision for payment of all its debts and liabilities, all of the assets of Citizens South Banking Corporation available for distribution. If preferred stock is issued, the holders thereof may have a priority over the holders of the common stock in the event of liquidation or dissolution. 98 Preemptive Rights. Holders of the common stock of Citizens South Banking Corporation will not be entitled to preemptive rights with respect to any shares that may be issued. The common stock is not subject to redemption. Preferred Stock None of the shares of Citizens South Banking Corporation's authorized preferred stock will be issued in the conversion. Preferred stock may be issued with preferences and designations as our Board of Directors may from time to time determine. Our Board of Directors may, without stockholder approval, issue preferred stock with voting, dividend, liquidation and conversion rights that could dilute the voting strength of the holders of the common stock and may assist management in impeding an unfriendly takeover or attempted change in control. TRANSFER AGENT The transfer agent and registrar for Citizens South Banking Corporation common stock is Registrar and Transfer Company, Cranford, New Jersey. EXPERTS The consolidated financial statements as of December 31, 2001 and 2000, and for the twelve months ended December 31, 2001 and September 30, 2000 and 1999, included in this prospectus and registration statement have been audited by Cherry Bekaert & Holland, L.L.P., independent auditors, as stated in their report appearing herein, and have been so included in reliance upon the report of such firm given on their authority as experts in accounting and auditing. The consolidated financial statements of Innes Street Financial Corporation at September 30, 2000 and 1999, and for the years then ended, appearing in this prospectus and registration statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report thereon appearing elsewhere herein, and are included in reliance upon such report given on the authority of such firm as experts in accounting and auditing. RP Financial, LC has consented to the publication herein of the summary of its report to Citizens South Banking Corporation setting forth its opinion as to the estimated pro forma market value of the common stock upon completion of the stock offering and its letter with respect to subscription rights. LEGAL MATTERS The legality of the common stock has been opined upon for Citizens South Banking Corporation by Luse Gorman Pomerenk & Schick, P.C., Washington, D.C., special counsel to Citizens South Banking Corporation. Certain legal matters will be passed upon for Keefe, Bruyette & Woods, Inc. by Muldoon Murphy & Faucette LLP, Washington, D.C. ADDITIONAL INFORMATION Citizens South Banking Corporation has filed with the Securities and Exchange Commission a registration statement under the Securities Act of 1933 with respect to the common stock offered hereby. As permitted by the rules and regulations of the Securities and Exchange Commission, this prospectus does not contain all the information set forth in the registration statement. Such information, including the appraisal report which is an exhibit to the registration statement, can be examined without charge at the public reference facilities of the Securities and Exchange Commission located at 450 Fifth Street, N.W., Washington, D.C. 20549, and copies of such material can be obtained from the SEC at prescribed rates. The Securities and Exchange Commission telephone number is 1-800-SEC-0330. In addition, the SEC maintains a web site (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC, including Citizens South Banking Corporation. The statements contained in this prospectus as to the contents of any contract or other document filed as an exhibit to the Registration Statement are, of necessity, brief descriptions of the material terms of, and should be read in conjunction with, such contract or document. 99 Citizens South Holdings, MHC has filed an Application on Form AC with respect to the conversion. This prospectus omits certain information contained in the Application. The Application may be examined at the principal office of the Office of Thrift Supervision, 1700 G Street, N.W., Washington, D.C. 20552, and at the Southeast Regional Office of the Office of Thrift Supervision, 1475 Peachtree Street, N.E., Atlanta, Georgia 30309. In connection with the stock offering, Citizens South Banking Corporation will register its common stock with the SEC under Section 12 of the Securities Exchange Act of 1934 and, upon such registration, Citizens South Banking Corporation and the holders of its stock will become subject to the proxy solicitation rules, reporting requirements and restrictions on stock purchases and sales by directors, officers and greater than 10% stockholders, the annual and periodic reporting and certain other requirements of the Securities Exchange Act of 1934. Under the stock issuance plan, Citizens South Banking Corporation has undertaken that it will not terminate such registration for a period of at least three years following the stock offering. 100 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Index to Consolidated Financial Statements Page Report of Independent Auditors .................................. F-2 Consolidated Statements of Condition ............................ F-3 Consolidated Statements of Operations ........................... F-4 Consolidated Statements of Comprehensive Income ................. F-5 Consolidated Statements of Changes in Stockholders' Equity ...... F-6 Consolidated Statements of Cash Flows ........................... F-7 Notes to Consolidated Financial Statements ...................... F-8 - F-34 F - 1 [CHERRY BEKAERT & HOLLAND LOGO] REPORT OF INDEPENDENT AUDITORS The Board of Directors Citizens South Banking Corporation We have audited the accompanying consolidated statements of condition of Citizens South Banking Corporation (formerly Gaston Federal Bancorp, Inc.) and subsidiaries as of December 31, 2001 and 2000 and the related consolidated statements of operations, comprehensive income, changes in stockholders' equity and cash flows for the years ended December 31, 2001, September 30, 2000 and September 30, 1999. These financial statements are the responsibility of management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Citizens South Banking Corporation and subsidiaries as of December 31, 2001 and 2000 and the results of their operations and their cash flows for the years ended December 31, 2001, September 30, 2000 and September 30, 1999, in conformity with accounting principles generally accepted in the United States of America. /s/ Cherry, Bekaert & Holland, L.L.P. Gastonia, North Carolina January 30, 2002 F - 2 CITIZENS SOUTH BANKING CORPORATION and SUBSIDIARIES Consolidated Statements of Condition (in thousands, except per share amounts)
March 31, December 31, December 31, 2002 2001 2000 --------- --------- --------- (Unaudited) Assets Cash and due from banks $ 3,414 $ 6,047 $ 4,157 Interest-earning bank balances 32,798 14,892 22,552 --------- --------- --------- Cash and cash equivalents 36,212 20,939 26,709 Investment securities available-for-sale 22,859 25,946 32,822 Mortgage-backed and related securities available-for-sale 23,007 25,405 22,955 Loans, net 323,528 334,321 158,820 Premises and equipment, net 8,564 8,640 4,163 Accrued interest receivable 2,097 1,727 1,352 Federal Home Loan Bank stock 3,390 3,893 2,177 Deferred income taxes 38 74 622 Real estate owned 1,698 1,470 -- Cash value of life insurance 6,569 6,479 2,773 Core deposit intangible 2,091 2,447 -- Goodwill 6,624 6,581 -- Other assets 6,608 9,659 357 --------- --------- --------- Total assets $ 443,285 $ 447,581 $ 252,750 ========= ========= ========= Liabilities and Equity Deposits $ 352,082 $ 353,692 $ 167,931 Advances from borrowers for taxes and insurance 910 515 351 Accrued interest payable 518 414 754 Advances from Federal Home Loan Bank 39,000 40,500 42,500 Repurchase agreements 2,009 1,557 237 Deferred Compensation 5,045 5,610 740 Other liabilities 1,484 3,663 474 --------- --------- --------- Total liabilities 401,048 405,951 212,987 Commitments and contingencies Stockholders' Equity Preferred stock, 10,000 shares authorized, none issued -- -- -- Common stock, $1.00 par value, 20,000 shares authorized, issued and outstanding 4,581 in 2002, 2001 and 2000 4,581 4,581 4,581 Additional paid-in-capital 16,843 16,843 16,673 Unallocated common stock held by Employee Stock Ownership Plan (1,211) (1,239) (1,352) Retained earnings, substantially restricted 25,957 25,105 23,931 Accumulated unrealized gain on securities available-for-sale, net of tax 843 1,116 591 Treasury stock of 372,372 and 362 shares at cost at March 31, 2002, December 31, 2001 and December 31, 2000 (4,776) (4,776) (4,661) --------- --------- --------- Total stockholders' equity 42,237 41,630 39,763 --------- --------- --------- Total liabilities and stockholders' equity $ 443,285 $ 447,581 $ 252,750 ========= ========= =========
See notes to consolidated financial statements. F - 3 CITIZENS SOUTH BANKING CORPORATION and SUBSIDIARIES Consolidated Statements of Operations (in thousands, except per share amounts)
Three Months Ended Twelve Months Ended ----------------------- ------------------------------------------------------- March 31, March 31, December 31, December 31, September 30, September 30, 2002 2001 2001 2000 2000 1999 --------- --------- ------------ ------------ ------------- ------------- (Unaudited) (Unaudited) (Unaudited) Interest income Loans $ 5,588 $ 3,153 $12,251 $13,320 $12,985 $11,998 Investment 423 814 2,697 2,058 2,127 2,059 securities Mortgage-backed and related securities 288 368 1,434 1,455 1,302 1,181 ------- ------- ------- ------- ------- ------- Total interest income 6,299 4,335 16,382 16,833 16,414 15,238 Interest expense Deposits 2,125 2,047 7,372 7,296 6,968 6,407 Borrowed funds 551 623 2,398 2,388 2,251 1,481 ------- ------- ------- ------- ------- ------- Total interest expense 2,676 2,670 9,770 9,684 9,219 7,888 ------- ------- ------- ------- ------- ------- Net interest income 3,623 1,665 6,612 7,149 7,195 7,350 Provision for loan losses 65 30 120 53 30 105 ------- ------- ------- ------- ------- ------- Net interest income after provision for loan losses 3,558 1,635 6,492 7,096 7,165 7,245 Noninterest income Fee income on deposit accounts 522 367 1,812 762 589 368 Income on mortgage banking and other lending activities 143 89 460 341 316 Gain on sale of securities 76 -- -- 229 225 1,272 Gain on sale of other assets 22 -- -- 42 32 117 Commissions on sales of financial products 47 39 213 763 603 300 Dividends on FHLB stock 55 39 147 164 156 113 Other income 163 84 374 172 147 204 ------- ------- ------- ------- ------- ------- Total noninterest income 1,028 618 3,006 2,473 2,068 2,374 Noninterest expense Compensation and benefits 1,406 832 3,850 3,725 3,643 4,012 Occupancy 360 159 733 612 624 458 Office supplies expense 101 46 199 184 158 NOW account expense 52 78 367 54 55 Amortization of intangible assets 356 -- -- -- -- -- Loss on sale of assets 10 9 10 873 -- -- Advertising 64 51 182 189 197 231 Professional services 79 47 222 242 221 290 Data processing 93 46 331 208 216 207 Deposit insurance 16 8 33 34 49 91 Other 507 235 1,165 854 798 971 ------- ------- ------- ------- ------- ------- Total noninterest expense 3,044 1,511 7,092 6,975 5,961 6,260 ------- ------- ------- ------- ------- ------- Income before income taxes 1,542 742 2,406 2,594 3,272 3,359 Provision for income taxes 550 230 702 846 1,087 1,198 ------- ------- ------- ------- ------- ------- Net income $ 992 $ 512 $ 1,704 $ 1,748 $ 2,185 $ 2,161 ======= ======= ======= ======= ======= ======= Earnings per share Basic earnings per share $ 0.24 $ 0.13 $ 0.42 $ 0.43 $ 0.53 $ 0.50 Diluted earnings per share $ 0.24 $ 0.13 $ 0.42 $ 0.43 $ 0.53 $ 0.50
See notes to consolidated financial statements. F - 4 CITIZENS SOUTH BANKING CORPORATION and SUBSIDIARIES Consolidated Statements of Comprehensive Income (in thousands, except per share amounts)
Three Months Ended Twelve Months Ended -------------------------------------- ------------------- March 31, March 31, December 31, 2002 2001 2001 ---------------- ---------------- ------------------ (Unaudited) (Unaudited) Net income $ 992 $ 512 $ 1,704 Other comprehensive income, net of tax: Unrealized gains (losses) on securities Cumulative effect of a change in accounting principle for the adoption of the provisions of SFAS No. 133 - - - Unrealized holding gains (losses) arising during period, net of tax effect of $130, $(249), $(292), $(607), $(50) and $308, respectively (231) 443 519 Reclassification adjustment for losses (gains) included in net income, net of tax effect of $24, $(3), $(3), $82, $81 and $458, respectively (42) 6 6 -------- -------- ---------- Other comprehensive income (273) 449 525 Comprehensive income $ 719 $ 961 $ 2,229 ======== ======== ========== Twelve Months Ended -------------------------------------------------------------------- December 31, September 30, September 30, 2000 2000 1999 ------------------- -------------------- ------------------- (Unaudited) Net income $ 1,748 $ 2,185 $ 2,161 Other comprehensive income, net of tax: Unrealized gains (losses) on securities Cumulative effect of a change in accounting principle for the adoption of the provisions of SFAS No. 133 (367) - - Unrealized holding gains (losses) arising during period, net of tax effect of $130, $(249), $(292), $(607), $(50) and $308, respectively 1,131 76 (548) Reclassification adjustment for losses (gains) included in net income, net of tax effect of $24, $(3), $(3), $82, $81 and $458, respectively (147) (144) (814) -------- -------- --------- Other comprehensive income 617 (68) (1,362) Comprehensive income $ 2,365 $ 2,117 $ 799 ======= ======= ========
See notes to consolidated financial statements. F - 5 CITIZENS SOUTH BANKING CORPORATION and SUBSIDIARIES Consolidated Statements of Changes in Stockholders' Equity (in thousands, except per share amounts)
Additional Unallocated Preferred Common Paid-In Common Stock Stock Stock Capital Held by ESOP ------------ ------------ ------------- ---------------- Balance, September 30, 1998 $ - $ 4,497 $ 15,721 $ (1,615) Comprehensive results: Net income - - - - Other comprehensive results, net of tax - - - - Issuance of 84 shares of $1.00 par value common stock for employee benefit plans - 84 930 - Allocation from shares purchased with loan to ESOP - - - 122 Cash dividends declared on common stock of $0.215 per share - - - - Repurchase of common stock - - - - ------------ ------------ ------------- ---------------- Balance, September 30, 1999 - 4,581 16,651 (1,493) Comprehensive results: Net income - - - - Other comprehensive results, net of tax - - - - Allocation from shares purchased with loan to ESOP - - 11 113 Cash dividends declared on common stock of $0.235 per share - - - - Repurchase of common stock - - - - ------------ ------------ ------------- ---------------- Balance, September 30, 2000 - 4,581 16,662 (1,380) Comprehensive results: Net income - - - - Other comprehensive results, net of tax - - - - Allocation from shares purchased with loan to ESOP - - 11 28 Cash dividends declared on common stock of $0.075 per share - - - - ------------ ------------ ------------- ---------------- Balance, December 31, 2000 - 4,581 16,673 (1,352) Comprehensive results: Net income - - - - Other comprehensive results, net of tax - - - - Allocation from shares purchased with loan to ESOP - - 170 113 Cash dividends declared on common stock of $0.30 per share - - - - Repurchase of common stock - - - - ------------ ------------ ------------- ---------------- Balance, December 31, 2001 - 4,581 16,843 (1,239) Comprehensive results: Net income - - - - Other comprehensive results, net of tax - - - - Allocation from shares purchased with loan to ESOP - - - 28 Cash dividends declared on common stock of $0.08 per share - - - - Repurchase of common stock - - - - ------------ ------------ ------------- ---------------- Balance, March 31, 2002 $ - $ 4,581 $ 16,843 $ (1,211) ============ ============ ============= ================ Retained Accumulated Earnings Unrealized Total Substantially Gains(Losses), Treasury Stockholders' Restricted net of tax Stock Equity ----------------- ----------------- ------------ ---------------- Balance, September 30, 1998 $ 21,430 $ 1,538 $ - $ 41,571 Comprehensive results: Net income 2,161 - - 2,161 Other comprehensive results, net of tax - (1,362) - (1,362) Issuance of 84 shares of $1.00 par value common stock for employee benefit plans - - - 1,014 Allocation from shares purchased with loan to ESOP - - - 122 Cash dividends declared on common stock of $0.215 per share (937) - - (937) Repurchase of common stock - - (2,860) (2,860) ----------------- ---------------- ------------ ---------------- Balance, September 30, 1999 22,654 176 (2,860) 39,709 Comprehensive results: Net income 2,185 - - 2,185 Other comprehensive results, net of tax - (68) - (68) Allocation from shares purchased with loan to ESOP - - - 124 Cash dividends declared on common stock of $0.235 per share (862) - - (862) Repurchase of common stock - - (1,801) (1,801) ----------------- ---------------- ------------ ---------------- Balance, September 30, 2000 23,977 108 (4,661) 39,287 Comprehensive results: Net income 63 - - 63 Other comprehensive results, net of tax - 483 - 483 Allocation from shares purchased with loan to ESOP - - - 39 Cash dividends declared on common stock of $0.075 per share (109) - - (109) ----------------- ---------------- ------------ ---------------- Balance, December 31, 2000 23,931 591 (4,661) 39,763 Comprehensive results: Net income 1,704 - - 1,704 Other comprehensive results, net of tax - 525 - 525 Allocation from shares purchased with loan to ESOP - - - 283 Cash dividends declared on common stock of $0.30 per share (530) - - (530) Repurchase of common stock - - (115) (115) ----------------- ---------------- ------------ ---------------- Balance, December 31, 2001 25,105 1,116 (4,776) 41,630 Comprehensive results: Net income 992 - - 992 Other comprehensive results, net of tax - (273) - (273) Allocation from shares purchased with loan to ESOP - - - 28 Cash dividends declared on common stock of $0.08 per share (140) - - (140) Repurchase of common stock - - - - ----------------- ---------------- ------------ ---------------- Balance, March 31, 2002 $ 25,957 $ 843 $ (4,776) $ 42,237 ================= ================ ============ ================
See notes to consolidated financial statements. F - 6 CITIZENS SOUTH BANKING CORPORATION and SUBSIDIARIES Consolidated Statements of Cash Flows (in thousands, except per share amounts)
Three Months Ended Twelve Months Ended ----------------------------- --------------------------------- March 31, March 31, December 31, December 31, 2002 2001 2001 2000 ------------ ------------ -------------- -------------- (Unaudited) (Unaudited) (Unaudited) Operating Activities Net Income $ 992 $ 512 $ 1,704 $ 1,748 Adjustments to reconcile net income to net cash provided by operating activities Provision for loan losses 65 30 120 53 Depreciation 181 93 360 385 Amortization of intangible assets 387 - - - Deferred income tax (benefit) (36) (319) (46) (112) (Gain) on sale of investments available-for-sale (66) 9 9 (229) (Gain) on sale of other assets (22) - - (42) Loss on sale of loans - - - 873 Deferred loan origination fees (48) (25) (228) 2 Issuance of shares for Recognition and Retention Plan - - - - Allocation of shares to the ESOP 28 28 283 124 (Increase) decrease in interest receivable (370) (26) 395 (327) Net (increase) decrease in other operating assets 142 (2,238) (1,043) (1,448) ------------ ------------ -------------- -------------- Net cash provided by operating activities 1,253 (1,936) 1,554 1,027 Investing Activities Net (increase) decrease in loans made to customers 9,481 (5,958) (4,866) (7,950) Proceeds from the sale of loans 1,311 - - 18,169 Proceeds from the sale of other assets 130 - 196 10 Proceeds from the sale of investments available-for-sale 2,000 - - 5,257 Proceeds from the sale of mortgage-backed and related securities 1,335 1,253 1,257 594 Maturities and prepayments of investment securities 913 2,333 12,821 2,342 Maturities and prepayments of mortgage-backed and related securities 4,347 1,243 7,899 3,403 Purchases of investment securities - (1,000) (5,420) (8,100) Purchases of mortgage-backed and related securities (3,493) (7,582) (9,041) (8,088) Sale (purchase) of FHLB stock 503 - - (402) Acquisition of Innes Street Financial, net of cash acquired - - (19,174) - Purchases of premises and equipment (104) (407) (1,244) (1,628) Net cash flows from other investing activities - - - - ------------ ------------ -------------- -------------- Net cash provided by (used for) investing activities 16,423 (10,118) (17,572) 3,607 Financing Activities Net increase (decrease) in deposits (1,610) 12,476 10,413 9,328 Dividends to stockholders (140) (135) (530) (730) Repurchase of common stock - (91) (115) (897) Advances from FHLB - 5,000 5,000 10,000 Repayments of advances from FHLB (1,500) (3,680) (5,680) (3,000) Increase (decrease) in repurchase agreements 452 336 1,320 237 Increase (decrease) in advances from borrowers for insurance and taxes 395 204 (160) (60) ------------ ------------ -------------- -------------- Net cash provided by financing activities (2,403) 14,110 10,248 14,878 Net increase (decrease) in cash and cash equivalents 15,273 2,056 (5,770) 19,512 Cash and cash equivalents at the beginning of the year 20,939 26,709 26,709 7,197 ----------- ------------ -------------- -------------- Cash and cash equivalents at the end of the year $ 36,212 $ 28,765 $ 20,939 $ 26,709 =========== ============ ============== ============== Twelve Months Ended ----------------------------------- September 30, September 30, 2000 1999 --------------- -------------- Operating Activities $ 2,185 $ 2,161 Net Income Adjustments to reconcile net income to net cash provided by operating activities 30 105 Provision for loan losses 400 335 Depreciation - - Amortization of intangible assets (117) (146) Deferred income tax (benefit) (225) (1,272) (Gain) on sale of investments available-for-sale (32) (117) (Gain) on sale of other assets - - Loss on sale of loans (60) (116) Deferred loan origination fees - 1,014 Issuance of shares for Recognition and Retention Plan 124 122 Allocation of shares to the ESOP (137) (6) (Increase) decrease in interest receivable (954) (287) Net (increase) decrease in other operating assets -------------- ------------- 1,214 1,793 Net cash provided by operating activities Investing Activities Net (increase) decrease in loans made to customers (8,898) (44,579) Proceeds from the sale of loans 10 13,136 Proceeds from the sale of other assets - 49 Proceeds from the sale of investments available-for-sale 2,256 5,882 Proceeds from the sale of mortgage-backed and related securities 594 493 Maturities and prepayments of investment securities 2,964 7,998 Maturities and prepayments of mortgage-backed and related securities 3,774 5,723 Purchases of investment securities (9,350) (6,515) Purchases of mortgage-backed and related securities (4,149) (11,867) Sale (purchase) of FHLB stock (402) (475) Acquisition of Innes Street Financial, net of cash acquired - - Purchases of premises and equipment (1,720) (612) Net cash flows from other investing activities - - -------------- ------------- Net cash provided by (used for) investing activities (14,921) (30,767) Financing Activities Net increase (decrease) in deposits 1,927 15,524 Dividends to stockholders (862) (937) Repurchase of common stock (1,801) (2,860) Advances from FHLB 15,000 18,000 Repayments of advances from FHLB (10,500) (2,000) Increase (decrease) in repurchase agreements 605 - Increase (decrease) in advances from borrowers for insurance and taxes 310 32 -------------- ------------- Net cash provided by financing activities 4,679 27,759 Net increase (decrease) in cash and cash equivalents (9,028) (1,215) Cash and cash equivalents at the beginning of the year 12,583 13,798 -------------- ------------- Cash and cash equivalents at the end of the year $ 3,555 $ 12,583 ============== =============
See notes to consolidated financial statements. F - 7 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 1 - Summary of Significant Accounting Policies Citizens South Banking Corporation (the "Company"), formerly Gaston Federal Bancorp, Inc., is a stock holding company whose activities are primarily limited to holding the stock of Citizens South Bank, formerly Gaston Federal Bank (the "Bank"). The Bank is a community-oriented federal stock savings bank engaged primarily in the business of offering deposits to customers through its branch offices and investing those deposits, together with funds generated from operations and borrowings, in residential, commercial and consumer loans. The Bank's wholly-owned subsidiary, Citizens South Financial Services, Inc. (doing business as Citizens South Investment Services) acts as an independent agent selling various financial products. Citizens South Holdings, MHC, a federal mutual holding company, owns 58% of the Company's outstanding shares of common stock. On December 31, 2001, Gaston Federal Bancorp, Inc. completed its acquisition of Innes Street Financial Corporation and its wholly-owned subsidiary, Citizens Bank, Inc. As part of the acquisition, Innes Street's stockholders received $18.50 per share for each of Innes Street's common stock issued and outstanding. The aggregate purchase price for the transaction was approximately $38 million. The transaction was accounted for using the purchase method. See Note 2 for additional information. Subsequent to the merger, the holding company changed its name to Citizens South Banking Corporation, the mutual holding company changed its name to Citizens South Holdings, MHC, and the banking entity changed its name to Citizens South Bank. Also, subsequent to the merger, the Bank's wholly-owned subsidiary changed its name to Citizens South Financial Services, Inc. (doing business as Citizens South Investment Services). During the three-month period ended December 31, 2000, the Company's Board of Directors adopted a resolution to change the Company's fiscal year-end from September 30th to December 31st effective October 1, 2000. The accounting and reporting policies of Citizens South Banking Corporation and its subsidiaries follow accounting principles generally accepted in the United States of America and policies within the financial services industry. The following is a summary of the more significant policies. Principles of Consolidation - The consolidated financial statements include the accounts of Citizens South Banking Corporation, its wholly-owned subsidiary, Citizens South Bank, and the Bank's wholly-owned subsidiary, Citizens South Financial Services, Inc. All significant intercompany accounts and transactions have been eliminated. Use of Estimates - The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Cash and Cash Equivalents - The Company considers cash on hand, cash due from banks, which are maintained in financial institutions, and interest-earning deposits, which are maintained with the Federal Home Loan Bank (FHLB), as cash and cash equivalents. Securities - Management determines the appropriate classification of securities at the time of purchase. Securities classified as available-for-sale are carried at fair value. Such securities are used to execute asset/liability management strategies and to manage liquidity. Adjustments for unrealized gains or losses, net of related income tax effect, are recorded as an addition or deduction from equity in the form of other comprehensive results. F - 8 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 1 - Summary of Significant Accounting Policies (continued) The Company has no securities classified as held-to-maturity. Amortization of premiums and accretion of discounts are included in interest income over the life of the related security, or in the case of mortgage-backed and related securities, the estimated life of the security. Gains or losses on the sale of securities are recognized on a specific identification, trade date basis. Loans and Allowance for Loan Losses - Loans are carried at their principal amount outstanding. Income on loans is accrued based upon the outstanding principal balance. Generally, loans are classified as nonaccrual, and the accrual of interest is discontinued, when the contractual payment of principal and interest has become 90 days past due or when, in management's judgment, principal or interest is not collectible in accordance with the terms of the obligation. Cash receipts on nonaccrual loans are applied to principal. The accrual of interest resumes when the loan returns to performing status. The allowance for loan losses is maintained at a level believed by management to be adequate to absorb losses that are known and losses that are expected to have been incurred in the 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 risks inherent in the portfolio. Loans are charged to the allowance at the time they are determined to be losses. Subsequent recoveries are credited to the allowance. Concentrations of Credit Risk - The Company makes loans to individuals and small businesses primarily in Gaston, Rowan, and Iredell Counties, North Carolina and surrounding counties. The Company has a diversified loan portfolio, and the borrowers' ability to repay their loans is not dependent upon any specific economic segment. Premises and Equipment - Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed over the estimated useful lives of the assets (from 3 to 30 years) primarily by the straight-line method. Leasehold improvements are amortized on a straight-line basis over the shorter of the estimated useful life of the improvement or the lease term. Intangible Assets - Intangible assets with finite lives are amortized over their estimated useful life. Goodwill is not amortized, but is evaluated for impairment on an annual basis. Other Real Estate Owned - Other real estate owned is comprised of real estate properties acquired in partial or total satisfaction of problem loans. The properties are recorded at the lower of cost or fair value less estimated costs to sell at the date acquired. Losses arising at the time of acquisition of such properties are charged against the allowance for loan losses. Subsequent write-downs that may be required to the carrying value of these properties are charged to noninterest expenses. Gains and losses realized from the sale of other real estate owned are included in noninterest income. Loan Origination Fees - Origination fees received and direct costs incurred are amortized to interest income over the contractual lives of the loans, using the level yield method. Income Taxes - Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Amounts provided for deferred income taxes relate primarily to differences between tax and financial reporting for unrealized gains and losses on securities available-for-sale, allowances for loan losses, depreciation, and deferred compensation. F - 9 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 1 - Summary of Significant Accounting Policies (continued) Advertising - Advertising costs are expensed as incurred. Reclassifications - Certain of the prior year amounts have been reclassified to conform to current year presentation; such reclassifications are immaterial to the financial statements. Comprehensive Income - SFAS No. 130, Reporting Comprehensive Income, establishes standards for the reporting and display of comprehensive income and its components in financial statements. SFAS No. 130 defines comprehensive income as net income, as currently reported, as well as unrealized gains and losses on assets available for sale and certain other items not currently included in the income statement. The disclosure requirements of SFAS No. 130 have been included in the Consolidated Statements of Comprehensive Income. Operating Segments - SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes standards for the way public business enterprises report information about operating segments. This statement also establishes standards for related disclosures about products, services, geographic areas and major customers. In adopting SFAS No. 131, the Company has determined that, using the definitions contained in the statement, all of its activities constitute only one reportable operating segment. Accounting for Derivatives - SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137 and SFAS No. 138, establishes accounting and reporting requirements for derivative instruments, including derivative instruments embedded in other contracts. The Company adopted the provisions of this statement effective October 1, 2000. In connection with the adoption of the provisions of SFAS No. 133, the Company transferred all securities previously designated as held-to-maturity at September 30, 2000, into the available-for-sale category. The transfer was accounted for at the fair values of the securities at September 30, 2000. The effect of the transfer was to decrease carrying values of these securities by approximately $603,000 and increase the deferred tax assets by approximately $236,000. The unrealized holding loss on the transferred securities, net of tax, of approximately $367,000 is reported in accumulated other comprehensive income as the cumulative effect of an accounting change. Business Combinations - SFAS No. 141, Business Combinations, establishes standards for the financial accounting and reporting for business combinations and supersedes APB Opinion No. 16, Business Combinations, and FASB Statement No. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises. The provisions of this statement apply to business combinations initiated after June 30, 2001. All business combinations are to be accounted for using the purchase method. The reporting and disclosure requirements of SFAS No. 141 have been included in the financial statements. Impact of Recently Adopted Accounting Standards - SFAS No. 142, Goodwill and Other Intangible Assets, was issued in June 2001 and establishes standards for the financial accounting and reporting for acquired goodwill and other intangible assets and supersedes APB Opinion No. 17, Intangible Assets. It addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. SFAS No. 142 also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Under SFAS No. 142, goodwill and intangible assets that have indefinite useful lives are not amortized but rather are tested at least annually for impairment. F - 10 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 1 - Summary of Significant Accounting Policies (continued) Intangible assets that have finite useful lives will continue to be amortized over their useful lives, but without the constraint of the 40-year maximum life required by SFAS No. 142. The provisions of SFAS No. 142 are required to be applied starting with fiscal years beginning after December 15, 2001. SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets, was issued in August 2001 and supersedes SFAS No. 121. SFAS No. 144 establishes standards for the financial accounting and reporting requirements for the impairment or disposal of long-lived assets. The provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001. Interim Financial Information (Unaudited) - In management's opinion, the interim financial information, which is unaudited, reflects all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial information as of and for the three-month periods ended March 31, 2002 and 2001, in conformity with generally accepted accounting principles. Operating results for the three-month period ended March 31, 2002, are not necessarily indicative of the results that may be expected for future periods. Accounting policies for the three-month period ended March 31, 2002, are consistent with those followed for the year ended December 31, 2001, except as follows. Effective January 1, 2002, the Company adopted the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The adoption of the provisions of SFAS No. 144 did not have a material impact on the consolidated financial statements of the Company. The Company is adopting the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, effective as of January 1, 2002. During the second quarter of 2002, the Company completed its initial analysis of potential impairment under the provisions of SFAS No. 142, and determined based on that analysis that goodwill was not impaired. Goodwill will be tested for impairment annually, or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company had no goodwill related to acquisitions initiated prior to July 1, 2001, or other intangible assets recorded prior to the adoption of the provisions of SFAS No. 142 whose carrying amounts or amortization were changed by the adoptions of the provisions of SFAS No. 142. Note 2 - Business Combination On December 31, 2001, Gaston Federal Bancorp, Inc. acquired 100% of the outstanding shares of common stock of Innes Street Financial Corporation and its wholly owned subsidiary, Citizens Bank, Inc. Accordingly, the results of operations of Innes Street Financial Corporation have not been included in the consolidated financial statements of the Company since the acquisition occurred at the close of business, December 31, 2001. As part of the acquisition, Innes Street's stockholders received $18.50 per share for each share of Innes Street's common stock issued and outstanding. The aggregate purchase price for the transaction was approximately $38 million. Innes Street Financial Corporation and its subsidiary have served the Salisbury, North Carolina area for over ninety years by providing this community and surrounding counties with general banking services. As a result of the acquisition, the Company will expand its market reach and provide its banking products in new markets in North Carolina that it had previously not been servicing. The Company also expects to reduce costs through economies of scale. F - 11 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 2 - Business Combination (continued) The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The Company is in the process of selling certain assets acquired in the acquisition; thus the allocation of the purchase price is subject to refinement if management's estimate of fair value of these assets to be sold is materially different from the actual sales price. December 31, 2001 ----------------- Cash and cash equivalents $ 6,793 Investment securities 2,600 Loans, net 170,527 Premises and equipment 3,801 Intangible assets 2,872 Goodwill 6,581 Other assets 28,616 -------- Total assets acquired 221,790 Deposits 175,350 Other liabilities 8,503 -------- Total liabilities assumed 183,853 -------- Net assets acquired $ 37,937 ======== Of the $2,872 of intangible assets, $2,447 was assigned to core deposit premium, which is being amortized over a 7-year life on an accelerated basis. The remaining intangibles relate to mortgage servicing rights. Goodwill of $6,581 represents the excess of the purchase price over the fair value of assets acquired and liabilities assumed, none of which is deductible for income tax purposes. F - 12 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 2 - Business Combination (continued) The following summarizes the results of operations as though the acquisition of Innes Street Financial Corporation had occurred at the beginning of each period. Year Ended December 31, ------------------------------- 2001 2000 ---- ---- Interest income $ 29,872 $ 29,287 Interest expense (18,106) (16,948) -------- -------- Net interest income 11,766 12,339 Provision for loan losses (146) (53) -------- -------- Net interest income after provision 11,620 12,286 Noninterest income 3,143 2,832 Noninterest expense (10,531) (10,760) -------- -------- Income before income taxes 4,232 4,358 Provision for income taxes 1,431 1,511 -------- -------- Net income $ 2,801 $ 2,847 ======== ======== Basic earnings per share $ 0.69 $ 0.70 Diluted earnings per share $ 0.68 $ 0.70 F - 13 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 3 - Investment Securities The aggregate book and fair values, as well as gross unrealized gains and losses, of investment securities as of March 31 and December 31 were as follows:
March 31, 2002 ---------------------------------------------------------------------- Book Unrealized Unrealized Fair Value Gains Losses Value ---------------------------------------------------------------------- Investment securities Available for Sale U.S. Treasury and other agencies $10,854 $ 224 $ - $11,078 Municipals 6,202 57 (73) 6,186 FHLMC stock 19 1,198 - 1,217 Corporate Bonds 2,012 51 - 2,063 Other equity securities 2,335 121 (141) 2,315 ------- ------ ----- ------- Total available-for-sale $21,422 $1,651 $(214) $22,859 ======= ====== ===== ======= March 31, 2002 ---------------------------------------------------------------------- Book Unrealized Unrealized Fair Value Gains Losses Value ---------------------------------------------------------------------- Mortgage-backed and related securities Available-for-Sale FNMA $ 3,735 $ 19 $ (19) $ 3,735 GNMA 9,734 22 (19) 9,737 SBA's 1,998 - (19) 1,979 FHLMC 7,592 28 (64) 7,556 ------- ------ ----- ------- Total mortgage-backed and related securities $23,059 $ 69 $(121) $23,007 ======= ====== ===== ======= December 31, 2001 ---------------------------------------------------------------------- Book Unrealized Unrealized Fair Value Gains Losses Value ---------------------------------------------------------------------- Investment securities Available for Sale U.S. Treasury and other agencies $11,902 $ 202 $ - $12,104 Municipals 6,205 44 (137) 6,112 FHLMC stock 19 1,259 - 1,278 Corporate Bonds 4,020 141 - 4,161 Other equity securities 2,248 108 (65) 2,291 ------- ------ ----- ------- Total available-for-sale $24,394 $1,754 $(202) $25,946 ======= ====== ===== =======
F - 14 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 3 - Investment Securities (continued)
December 31, 2001 ---------------------------------------------------------------------- Book Unrealized Unrealized Fair Value Gains Losses Value ---------------------------------------------------------------------- Mortgage-backed and related securities Available-for-Sale FNMA $ 3,368 $ 42 $ - $ 3,410 GNMA 11,042 101 (5) 11,138 SBA's 2,103 - (18) 2,085 FHLMC 8,736 53 (17) 8,772 ------- ------ ----- ------- Total mortgage-backed and related securities $25,249 $ 196 $ (40) $25,405 ======= ====== ===== ======= December 31, 2000 ---------------------------------------------------------------------- Book Unrealized Unrealized Fair Value Gains Losses Value ---------------------------------------------------------------------- Investment securities Available-for-Sale U.S. Treasury and other agencies $22,204 $ - $ (92) $22,112 Municipals 6,216 - (179) 6,037 Corporate bonds 3,001 37 - 3,038 FHLMC stock 19 1,303 - 1,322 Other equity securities 243 70 - 313 ------- ------ ----- ------- Total available-for-sale $31,683 $1,410 $(271) $32,822 ======= ====== ===== ======= Mortgage-backed and related securities Available-for-Sale FHLMC $ 5,241 - (44) 5,197 FNMA 2,829 - (37) 2,792 GNMA 11,231 - (67) 11,164 SBA's 3,904 - (102) 3,803 ------- ------ ----- ------- Total mortgage-backed and related securities $23,205 $ - $(250) $22,955 ======= ====== ===== =======
The book value and estimated fair value of debt securities at March 31, 2002 and December 31, 2001, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. F - 15 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 3 - Investment Securities (continued)
March 31, 2002 December 31, 2001 ------------------------------------- -------------------------------------- Book Fair Book Fair Value Value Value Value ------------------------------------- -------------------------------------- Available-for-Sale Due in one year or less $ 2,655 $ 2,711 $ 2,068 $ 3,329 Due after one year through five years 6,226 6,375 9,341 9,633 Due after five years through ten years 7,730 7,848 8,281 8,348 Due after ten years 2,457 2,393 2,456 2,345 Equities 2,354 3,532 2,248 2,291 ------- ------- ------- ------- $21,422 $22,859 $24,394 $25,946 ======= ======= ======= ======= Mortgage-backed and related securities $23,059 $23,007 $25,249 $25,405 ======= ======= ======= =======
Gross realized gains on the sale of securities available for sale were $76, $0, $0, $229, $256 and $1,282 for the quarter ended March 31, 2002, the quarter ended March 31, 2001, the year ended December 31, 2001, the year ended December 31, 2000, the year ended September 30, 2000, and year ended September 30, 1999, respectively. Gross realized losses on the sale of securities available for sale were $10, $9 $9, $0, $31 and $10 for the quarter ended March 31, 2002, the quarter ended March 31, 2001, the year ended December 31, 2001, the year ended December 31, 2000, the year ended September 30, 2000 and the year ended September 30, 1999, respectively. After-tax net gains (losses) on the sale of securities were $42, $(6) $(6), $147, $144 and $814 for the quarter ended March 31, 2002, the quarter ended March 31, 2001, the year ended December 31, 2001, the year ended December 31, 2000, the year ended September 30, 2000 and the year ended September 30, 1999, respectively. Investment securities having a carrying amount of approximately $11,871 and $11,292 have been pledged as collateral to secure public deposits at December 31, 2001 and March 31, 2002, respectively. Investment securities having a carrying amount of $2,500 have been pledged as collateral for repurchase agreements at December 31, 2001 and March 31, 2002. F - 16 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 4 - Loans and Allowance for Loan Losses The following is a summary of loans outstanding by category:
March 31, December 31, December 31, 2002 2001 2000 --------- ------------ ------------ Real estate: One-to-four family residential $187,086 $196,572 $109,907 Multi-family residential 9,016 8,696 2,003 Commercial mortgage 17,344 21,745 5,381 Construction 15,468 16,525 9,597 Land 6,577 6,798 809 Commercial 31,198 27,622 19,569 Consumer 65,593 64,883 18,183 -------- -------- -------- Gross loans 332,282 342,841 165,449 Less: Loans in process 5,649 5,306 4,758 Deferred loan fees, net 83 78 305 Allowance for loan losses 3,022 3,136 1,566 -------- -------- -------- Net loans $323,528 $334,321 $158,820 ======== ======== ========
The Company evaluates impairment of its residential mortgage and consumer loans on a collective basis. Commercial loans individually evaluated and considered impaired under SFAS No. 114 at March 31, 2002 and December 31, 2001 and 2000 were immaterial. F - 17 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 4 - Loans and Allowance for Loan Losses (continued) Changes in the allowance for loan losses for the quarter ended March 31, 2002, the quarter ended March 31, 2001, the year ended December 31, 2001, the year ended December 31, 2000, the year ended September 30, 2000, and the year ended September 30, 1999 were as follows:
Quarter Quarter Ended Ended Year Ended Year Ended Year Ended Year Ended March 31, March 31, December 31, December 31, September 30, September 30, 2002 2001 2001 2000 2000 1999 -------------------------------------------------------------------------------------- Balance at beginning of year $3,136 $1,566 $1,566 $1,517 $1,509 $1,411 Reserve acquired in acquisition - - 1,553 - - - Provision for loan losses 65 30 120 53 30 105 Recoveries on loans previously charged off - 1 1 1 1 2 Loans charged off (179) (75) (104) (5) (3) (8) ------ ------ ------ ------ ------ ------ Balance at end of year $3,022 $1,522 $3,136 $1,566 $1,537 $1,510 ====== ====== ====== ====== ====== ======
Directors, executive officers, and associates of such persons were customers of and had transactions with the Bank in the ordinary course of business. Included in such transactions are outstanding loans and commitments, all of which were made under normal credit terms and did not involve more than normal risk of collection. The aggregate amount of these loans were $2,833, 2,542 and $2,831 at March 31, 2002, December 31, 2001 and December 31, 2000, respectively. During the quarter ended March 31, 2002, new loans of $342 were made and payments totaled $51. During the year ended December 31, 2001, new loans of $982 were made and payments totaled $1,271. During the year ended December 31, 2000, new loans of $667 were made and payments totaled $647. As part of the Bank's interest rate risk management, in November 2000, the Bank sold 157 fixed-rate mortgage loans with a book value of $18,202 with servicing released. These fixed-rate mortgage loans had a weighted average coupon of 6.3% and a weighted average maturity of 153 months. The Company recognized a pre-tax loss of $873 on this sale. During the year ended September 30, 2000, the Bank sold one loan with a book value of $9,457 at a gain of $543. The Bank held no loans for sale at March 31, 2002, December 31, 2001 and December 31, 2000. F - 18 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 5 - Premises and Equipment Premises and equipment at December 31 are summarized as follows:
March 31, 2002 December 31, 2001 December 31, 2000 ------------------------------------------------------------------ Land $ 2,852 $ 2,852 $1,154 Buildings 5,617 5,637 3,106 Land Improvements 111 111 111 Furniture and equipment 3,039 2,911 2,303 ------- ------- ------ 11,619 11,511 6,674 Less: accumulated depreciation (3,055) 2,871 2,511 ------- ------- ------ $ 8,564 $ 8,640 $4,163 ======= ======= ======
Note 6 - Intangible Assets Amortized intangible assets at March 31, 2002 and December 31, 2001 are summarized as follows:
March 31, 2002 December 31, 2001 ------------------------------------ Core deposit intangible $2,447 $2,447 Mortgage servicing rights 425 425 ------ ------ 2,872 2,872 Less: accumulated amortization 387 - ------ ------ $2,485 $2,872 ====== ======
Amortization expense for intangible assets subject to amortization was $387 during the three months ended March 31, 2002 and $0 during the year-ended December 31, 2001 since these intangibles were recognized on December 31, 2001 in connection with the acquisition of Innes Street Financial Corporation as described in Note 2. There were no amortized intangible assets at December 31, 2000. Estimated amortization expense for the next five succeeding fiscal years ending December 31 are as follows: 2002 $1,073 2003 $ 492 2004 $ 329 2005 $ 246 2006 $ 184 The balance of goodwill was $6,624 and $6,581 at March 31, 2002 and December 31, 2001. The increase in goodwill is due to costs of the acquisition that exceeded the initial estimates made during the purchase price allocation. There was no goodwill at December 31, 2000. F - 19 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 7 - Deposits Deposit balances and interest expense and average rates paid for the quarter ended March 31, 2002 and the years ended December 31, 2001, December 31, 2000, September 30, 2000, and September 30, 1999 are summarized as follows:
March 31, December 31, December 31, 2002 2001 2000 ------------------------------- ------------------------------- ------------------------------ Actual Interest Average Actual Interest Average Actual Interest Average Balance Expense Rate Balance Expense Rate Balance Expense Rate -------- ------- ------- -------- -------- ------- ------- ------- ------- Noninterest bearing $ 9,680 $ - - $ 7,953 $ - - $ 7,096 $ - - Interest bearing checking 25,497 23 0.4% 25,330 186 1.2% 14,562 230 1.7% Money market deposit 30,946 122 1.5% 29,489 460 2.7% 14,690 488 3.5% Savings 46,385 169 1.5% 44,011 398 2.1% 17,922 636 3.0% Certificates of deposit 239,574 1,811 3.0% 246,909 6,328 5.4% 113,661 5,942 5.6% -------- ------ --- -------- ------ --- -------- ------ --- $352,082 $2,125 2.8% $353,692 $7,372 4.2% $167,931 $7,296 4.7% ======== ====== === ======== ====== === ======== ====== === September 30, September 30, 2000 1999 ---------------------------- ---------------------------- Actual Interest Average Actual Interest Average Balance Expense Rate Balance Expense Rate ------- -------- ------- ------- ------- ------- Noninterest bearing $ 5,272 $ - - $ 6,481 $ - - Interest bearing checking 14,009 226 1.1% 11,916 194 1.6% Money market deposit 14,909 452 3.2% 13,709 396 2.1% Savings 19,189 692 3.1% 23,869 717 3.2% Certificates of Deposit 107,973 5,598 5.4% 103,450 5,100 5.2% -------- ------ --- -------- ------ --- $161,352 $6,968 4.3% $159,425 $6,407 4.1% ======== ====== === ======== ====== ===
Contractual maturities of certificates of deposit as of March 31, 2002 and December 31, 2001 are as follows:
March 31, 2002 December 31, 2001 --------------- ----------------- Under 1 year $213,803 $221,439 1 to 2 years 15,689 20,096 2 to 3 years 7,882 5,194 3 to 4 years 2,200 180 -------- -------- $239,574 $246,909 ======== ========
Certificates of deposit in excess of $100 totaled $52,783, $51,044 and $24,926 at March 31, 2002, December 31, 2001 and December 31, 2000, respectively, and may not be fully insured by the FDIC. Interest paid on deposits and other borrowings was $2,312 for the quarter ended March 31, 2002, $1,814 for the quarter ended March 31, 2001, $10,167 for the year ended December 31, 2001, $8,922 for the year ended December 31, 2000, $8,922 for the year ended September 30, 2000 and $7,787 for the year ended September 30, 1999, respectively. F - 20 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 7 - Deposits (continued) Directors, executive officers, and associates of such persons were customers of and had transactions with the Bank in the ordinary course of business. Included in such transactions are deposit accounts, all of which were made under normal terms. The aggregate amount of these deposit accounts was $3,878, $1,693 and $1,613 at March 31, 2002, December 31, 2001 and December 31, 2000, respectively. The deposits of the Bank are insured by the Savings Association Insurance Fund (SAIF), one of two funds administered by the FDIC. The Bank's annual SAIF premium rates were $.0176 per $100 of deposits for the quarter ended March 31, 2002, $.0186 for the year ended December 31, 2001, $.0203 for the year ended December 31, 2000 and $.0493 for the year ended September 30, 1999. Note 8 - Advances from the Federal Home Loan Bank Advances from the Federal Home Loan Bank of Atlanta are pursuant to lines of credit and are collateralized by a lien on qualifying first mortgage loans in an amount necessary to satisfy outstanding indebtedness plus accrued interest. Advances had interest rates ranging from 4.69% to 6.60% at March 31, 2002, 3.59% to 6.60% at December 31, 2001 and 4.69% to 6.60% at December 31, 2000. The total amount available on the line of credit is 20% of total assets of the Bank. The unused portion of the line of credit available to the Company at March 31, 2002 was approximately $71,048. Maturities of advances are as follows:
March 31, December 31, December 31, 2002 2001 2000 --------- ------------ ------------ Advances from FHLB due: Less than 1 year $ 5,000 $ - $ - 1 to 2 years - 6,500 - 2 to 3 years 12,000 5,000 6,500 3 to 4 years - 7,000 7,000 4 to 5 years - - 7,000 5 to 10 years 22,000 22,000 22,000 After 10 years - - - ------- ------- ------- $39,000 $40,500 $42,500 ======= ======= =======
Interest rates on certain convertible advances may be reset on certain dates at the option of the Federal Home Loan Bank in accordance with the terms of the note. The Bank has the option of repaying the outstanding advance or converting the interest rate from a fixed rate to a floating rate at the time the advance is called by the Federal Home Loan Bank. The Bank currently has two $8.0 million advances that are callable quarterly until they mature in January 2005. The Bank also has five other advances that have a one-time call option. Interest rates on $2.0 million may reset in 2002, $8.0 million may reset in 2003, $8.0 million may reset in 2004, and $5.0 million may reset in 2005. F - 21 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 9 - Income Taxes The provision for income taxes is summarized below:
Quarter Year Ended Year Ended Year Ended Year Ended Ended December 31 December 31 September 30 September 30 March 31 2002 2001 2000 2000 1999 ------------- ----------- ----------- ------------ ------------ Currently payable Federal $517 $735 $870 $1,100 $1,218 State 73 13 88 104 126 ---- ---- ---- ------ ------ 590 748 958 1,204 1,344 Deferred Federal (35) (37) (71) (76) (105) State (5) (9) (41) (41) (41) ---- ---- ---- ------ ------ (40) (46) (112) (117) (146) ---- ---- ---- ------ ------ Total income taxes $550 $702 $846 $1,087 $1,198 ==== ==== ==== ====== ======
The reasons for the difference between consolidated income tax expense and the amount computed by applying the statutory federal income tax rate of 34% to income before income taxes were as follows:
Quarter Ended Year Ended Year Ended Year Ended Year Ended March 31 December 31 December 31 September 30 September 30 2002 2001 2000 2000 1999 -------- ----------- ----------- ------------ ------------ Federal income taxes at statutory rate $524 $818 $882 $1,113 $1,142 State income taxes, net of federal benefit 45 (2) 32 42 56 Effect of federal tax exempt interest (29) (91) (97) (92) (50) Other 10 (23) 29 24 50 ----- ----- ----- ------ ------ $550 $702 $846 $1,087 $1,198 ===== ===== ===== ====== ====== Effective tax rate 35.7% 29.2% 32.6% 33.2% 35.7% ===== ===== ===== ====== ======
F - 22 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 9 - Income Taxes (continued) Income taxes payable (receivable) are included in other liabilities and were $324, ($551) and $60 at March 31, 2002, December 31, 2001 and December 31, 2000, respectively. Income taxes paid for the year ended December 31, 2001, the year ended December 31, 2000, the year ended September 30, 2000 and the year ended September 30, 1999, were $936, $1,017, $1,176 and 1,315, respectively. The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at March 31, 2002, December 31, 2001, and December 31, 2000 are as follows:
March 31 December 31 December 31 2002 2001 2000 -------- ----------- ----------- Deferred tax assets Deferred compensation $1,219 $1,437 $289 Allowance for loan losses 1,218 1,262 452 Excess carrying value of liabilities assumed for financial reporting purposes over tax basis 480 513 - Other 62 95 246 ------ ------ ---- Gross deferred tax assets 2,979 3,307 987 Deferred tax liabilities Excess carrying value of assets acquired for financial reporting purposes over tax basis 1,861 2,011 - Deferred loan fees 301 299 - Unrealized gain on securities available-for-sale 529 683 365 Other 250 240 - ------ ------ ---- Gross deferred tax liabilities 2,941 3,233 365 ------ ------ ---- Net deferred tax asset $ 38 $ 74 $622 ====== ====== ====
The Company, in accordance with SFAS No. 109, did not record a deferred tax liability of approximately $3,140 as of December 31, 2001 related to the cumulative special bad debt deduction for savings and loan associations recognized for income tax reporting prior to September 30, 1988, the Bank's base year. Management believes that the Company will fully realize deferred tax assets based on future taxable temporary differences, refundable income taxes from carryback years, and current levels of operating income. F - 23 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 10 - Commitments to Extend Credit Commitments to extend credit are agreements to lend as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments to extend credit are as follows:
March 31 2002 December 31 2001 December 31 2000 ------------- ---------------- ---------------- Mortgage loan commitments $ 1,665 $ 2,198 $ 368 Commercial loan commitments 2,263 6,315 3,905 Consumer loan commitments 1,020 251 68 Unused lines of credit Commercial 16,983 12,275 11,078 Consumer 42,696 41,211 20,437
Mortgage loan commitments at March 31, 2002 are fixed rates ranging from 5.63% to 6.38%. Commercial loan commitments at March 31, 2002 either have fixed rates ranging from 4.25% to 7.50% or variable rates ranging from the Bank's prime rate (4.75% at March 31, 2002) plus 0% to 1%. Mortgage loan commitments at December 31, 2001 are at fixed rates ranging from 5.25% to 6.375%. Commercial loan commitments at December 31, 2001 either have fixed rates ranging from 4.75% to 8.00% or variable rates ranging from the Bank's prime rate (4.75% at December 31, 2001) plus 0% to 1%. Commitment periods are typically 60 days. Note 11 - Regulatory Capital Requirements The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain commitments as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. The Bank is required to maintain: tangible capital of at least 1.5% of adjusted total assets; core capital of at least 4.0% of adjusted total assets; and total capital of at least 8.0% of risk weighted assets. At March 31, 2002, the Bank's tangible capital and core capital were both $28,217 or 6.50% of tangible assets, and total capital was $31,778 or 10.48% of risk-weighed assets. At December 31, 2001, the Bank's tangible capital and core capital were both $26,922 or 6.17% of tangible assets, and total capital was $30,616 or 10.25% of risk-weighted assets. The Company's primary regulator, the Office of Thrift Supervision, informed the Bank that it was in the well-capitalized category as of the most recent regulatory examination, and management is not aware of any events that have occurred since that would have changed its classification. F - 24 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 11 - Regulatory Capital Requirements (continued)
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ---------------------- ----------------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio --------- --------- --------- --------- ---------- --------- (dollars in thousands) (dollars in thousands) (dollars in thousands) As of March 31, 2002 Total Risk-Based Capital (to Risk-Weighted Assets) $31,778 10.48% $24,267 8.00% $30,334 10.00% Tier 1 Capital (to Risk-Weighted Assets) 28,217 9.30% 12,133 4.00% 18,200 6.00% Tier 1 Capital (to Adjusted Total Assets) 28,217 6.50% 17,377 4.00% 21,721 5.00% Tangible Capital (to Adjusted Total Assets) 28,217 6.50% 6,516 1.50% 13,033 3.00% As of December 31, 2001 Total Risk-Based Capital (to Risk-Weighted Assets) $30,616 10.25% $23,892 8.00% $29,865 10.00% Tier 1 Capital (to Risk-Weighted Assets) 26,922 9.01% 11,946 4.00% 17,919 6.00% Tier 1 Capital (to Adjusted Total Assets) 26,922 6.17% 17,440 4.00% 21,800 5.00% Tangible Capital (to Adjusted Total Assets) 26,922 6.17% 6,540 1.50% 13,080 3.00% As of December 31, 2000 Total Risk-Based Capital (to Risk-Weighted Assets) $38,069 25.48% $11,952 8.00% $14,940 10.00% Tier 1 Capital (to Risk-Weighted Assets) 35,917 24.04% 5,976 4.00% 8,964 6.00% Tier 1 Capital (to Adjusted Total Assets) 35,917 14.29% 10,078 4.00% 12,598 5.00% Tangible Capital (to Adjusted Total Assets) 35,917 14.29% 3,779 1.50% 7,559 3.00%
F - 25 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 12 - Employee Benefit Plans The Bank provides supplemental benefits to substantially all employees through a 401(k) savings plan. Eligible participants may contribute up to 15% of base salary, with the Bank providing matching contributions of 50% of employee contributions up to 6% of compensation. The plan also provides for discretionary employer contributions. Total expense relating to this plan was $22 for the quarter ended March 31, 2002, $14 for the quarter ended March 31, 2001, $62 for the year ended December 31, 2001, $141 for the year ended December 31, 2000, $59 for the year ended September 30, 2000, $48 for the year ended September 30, 1999. The Bank also maintains nonqualified deferred compensation and/or supplemental retirement plans for certain of its directors. During 2001, the Bank added a similar plan for certain executive employees. Total expense for the plans was $94 for the quarter ended March 31, 2002, $29 for the quarter ended March 31, 2001, $300 for the year ended December 31, 2001, $86 for the year ended December 31, 2000, $175 for the year ended September 30, 2000, and $142 for the year ended September 30, 1999. The Company maintains non-qualified deferred compensation plans for key employees and directors: a diversified and a non-diversified plan. The eligible employees may defer a portion of their compensation and the directors may defer a portion of their directors' fees. The deferred assets are maintained in rabbi trusts, which are included in Other Assets of the Company. The assets are accounted for at market value in accordance with SFAS Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, with the resulting gains or losses in value recorded as an adjustment to the fair value of the deferred compensation obligation. On July 1, 2000, the Company terminated its participation in the Financial Institutions Retirement Fund, a multiemployer, qualified, noncontributory defined benefit pension plan that covered substantially all employees of the Bank meeting certain age and service requirements. As a result of the termination, plan participants who had accumulated a balance in the plan of less than $3.5 or who were 55 years of age or older on the termination date received a lump sum payment equal to their balance accumulated in the plan. The balances of those plan participants who had accumulated an amount of $3.5 or greater in the plan and who were less than 55 years of age on the termination date remain in the plan until those participants reach the age of 55 years. The plan requires employers to fund amounts necessary to meet ERISA minimum funding requirements. Total expense relating to this plan was $85 in the year ended September 30, 2000 recognized prior to the termination of the plan on July 1, 2000. Separate company information relating to the Bank is not available. 1999 Stock Option Plan - On April 12, 1999, the Company's shareholders approved the Citizens South Bank 1999 Stock Option Plan that provided the issuance of 211,335 options for directors and officers to purchase the Company's common stock. The Company applies the provisions of Accounting Principles Board Opinion No. 25 in accounting for the plan and accordingly, no compensation expense has been recognized in connection with the granting of the stock options. In accordance with SFAS No. 123, Accounting for Stock-Based Compensation, the Company adopted the disclosure-only option and elected to apply the provisions of APB No. 25 for financial statement purposes. Had the compensation cost for the Company's stock option plan been determined in accordance with the fair-value accounting provisions of SFAS No. 123, net income, basic earnings per share, and diluted earnings per share would have been as follows: F - 26 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 11 - Employee Benefit Plans (continued)
Year Ended Year Ended Year Ended Year Ended December 31, December 31, September 30, September 30, 2001 2000 2000 1999 -------------- -------------- --------------- ------------- Net income: As reported $1,704 $1,748 $2,185 $2,161 Pro forma $1,600 $1,555 $1,935 $1,749 Basic earnings per share: As reported $ 0.42 $ 0.43 $ 0.53 $ 0.50 Pro forma $ 0.39 $ 0.38 $ 0.47 $ 0.41 Diluted earnings per share: As reported $ 0.42 $ 0.43 $ 0.53 $ 0.50 Pro forma $ 0.39 $ 0.38 $ 0.47 $ 0.41
The following is a summary of stock option activity and related information for the years ended December 31, 2001, December 31, 2000, September 31, 2000 and September 30, 1999.
Year Ended Year Ended December 31, 2001 December 31, 2000 ---------------------- --------------------------- Weighted Avg. Weighted Avg. Options Exercise Price Options Exercise Price ------- ------------- ------- -------------- Outstanding- Beginning of period $192 $12.05 $ 200 $12.05 Granted - - 3 12.00 Exercised - - - - Forfeited - - (11) 12.0 ---- ----- ----- ------ Outstanding-end of period 192 $12.05 192 $12.05 ==== ===== Exercisable-end of period 134 $12.03 107 $12.02 ==== ===== Weighted average fair value of options granted during the period $ 0 $3.53 ==== =====
F - 27 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 12 - Employee Benefit Plans (continued)
Year Ended Year Ended September 30, 2000 September 30, 1999 --------------------------- ------------------------------- Weighted Avg. Weighted Avg. Options Exercise Price Options Exercise Price ------- -------------- ------- -------------- Outstanding- Beginning of period $200 $12.05 $ - $ - Granted 3 12.00 200 12.05 Exercised - - - - Forfeited (3) 12.00 - - ----- ------- ----- ------- Outstanding-end of period 200 $12.05 200 $12.05 ===== ===== Exercisable-end of period 110 $12.00 83 $12.02 ===== ===== Weighted average fair value of options granted during the period $2.57 $2.57 ===== =====
During the quarter ended March 31, 2002, 0 shares were exercised and 10 shares were granted. Exercise prices for options outstanding as of March 31, 2002, December 31, 2001, and December 31, 2000, ranged from $12.00 to $13.00. The weighted average remaining contractual life of those options is approximately three years at March 31, 2002 and December 31, 2001 and approximately four years at December 31, 2000. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for the year ended December 31, 2001, and the year ended December 31, 2000; dividend yield of 2.08%, expected volatility of 22%, a risk-free interest rate of 6.00%, and expected lives of 7 years for the options. Employee Stock Ownership Plan - The Bank established an Employee Stock Ownership Plan (ESOP). The ESOP is a tax-qualified retirement plan designed to invest primarily in the Company's common stock. All full-time employees of the Bank who have completed one year of service with the Bank will be eligible to participate in the ESOP. The ESOP utilized funds borrowed from the Company totaling $1,691, to purchase approximately 8%, or 169 shares of the Company's common stock issued in the Conversion. The loan to the ESOP will be primarily repaid with contributions from the Bank to the ESOP over a period not to exceed 15 years. Under the terms of the ESOP, the Bank makes contributions to the ESOP sufficient to cover all payments of principal and interest as they become due. The loan had an outstanding balance of $1,240 with an interest rate of 4.75%, $1,240 with an interest rate of 4.75%, $1,353 with an interest rate of 9.50% at March 31, 2002, December 31, 2001 and December 31, 2000, respectively. The interest rate on the loan is based on the Bank's prime rate. F - 28 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 12 - Employee Benefit Plans (continued) Shares purchased with the loan proceeds are held in a suspense account by the trustee of the plan for future allocation among participants as the loan is repaid. Contributions to the ESOP and shares released from the suspense account are allocated among participants on the basis of compensation as described in the plan. The number of shares released to participants will be determined based upon the percentage of principal and interest payments made during the year divided by the total remaining principal and interest payments including the current year's payment. Participants will vest in the shares allocated to their respective accounts over a period not to exceed 5 years. Any forfeited shares are allocated to the then remaining participants in the same proportion as contributions. As of March 31, 2002, 60 shares have been allocated to participants and 109 shares remain unallocated. The fair value of the unallocated shares was $1,779 at March 31, 2002. As of December 31, 2001, 57 shares have been allocated to participants and 112 shares remain unallocated. The fair value of the unallocated shares was $1,684 at December 31, 2001. The Company recognizes compensation expense attributable to the ESOP ratably over the fiscal year based upon the estimated number of ESOP shares to be allocated each December 31st. The Company recognized $315, $85, $124 and $128 as compensation expense in the twelve-month periods ended December 31, 2001, December 31, 2000, September 30, 2000 and September 30, 1999, respectively. The trustee for the ESOP must vote all allocated shares held in the ESOP trust in accordance with the instructions of the participants. Unallocated shares held by the ESOP trust are voted by the trustee in a manner calculated to most accurately reflect the results of the allocated ESOP shares voted, subject to the requirements of the Employee Retirement Income Security Act of 1974, as amended (ERISA). Note 13 - Fair Value of Financial Instruments The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. The estimates are significantly affected by the assumptions used, including discount rates and estimates of future cash flows. These estimates may differ substantially from amounts that could be realized in an immediate sale or settlement of the instrument. Fair value approximates book value for the following financial instruments due to their short-term nature: cash and due from banks, interest-earning bank balances, and advances from customers for taxes and insurance. Fair value for investment securities and mortgage-backed and related securities are based on quoted market prices. If a quoted market price is not available, fair value is estimated using market prices for similar securities. Fair value for variable rate loans that reprice frequently is based on the carrying value reduced by an estimate of credit losses inherent in the portfolio. Fair value for all other loans is estimated by discounting their future cash flows using interest rates currently being offered for loans of comparable terms and credit quality. Fair value for demand deposit accounts and interest-bearing accounts with no fixed maturity is equal to the carrying value. Certificate of deposit fair values are estimated by discounting cash flows from expected maturities using interest rates currently being offered for similar instruments. F - 29 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 13 - Fair Value of Financial Instruments (continued) The carrying amount of repurchase agreements approximates fair value due to the short-term nature of the agreements. Fair value for the advances from the Federal Home Loan Bank Board is based on discounted cash flows using current interest rates. At March 31, 2002, December 31, 2001 and December 31, 2000, the Company had outstanding unfunded commitments to extend credit offered in the normal course of business. Fair values of these commitments are based on fees currently charged for similar instruments. At March 31, 2002, December 31, 2001 and December 31, 2000, the carrying amounts and fair values of these off-balance sheet financial instruments were immaterial. The Company has used management's best estimates of fair values of financial instruments based on the above assumptions. This presentation does not include certain financial instruments, nonfinancial instruments or certain intangible assets such as customer relationships, deposit base intangibles, or goodwill. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The estimated fair values of financial instruments as of March 31 and December 31 were as follows:
March 31, 2002 December 31, 2001 December 31, 2000 -------------------------- --------------------------- -------------------------- Carrying Estimated Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value Amount Fair Value -------------------------- --------------------------- -------------------------- Financial assets Cash and due from banks $ 3,414 $ 3,414 $ 6,048 $ $ 6,048 $ 4,157 $ 4,157 Interest-earning bank balances 32,798 32,798 14,892 14,892 22,552 22,552 Investment and mortgage- Backed securities 45,866 45,866 51,351 51,351 55,777 55,777 Loans 323,528 326,288 334,321 335,562 158,820 157,138 Financial liabilities Deposits 352,082 353,211 353,692 355,528 167,931 165,239 Repurchase agreements 2,009 2,009 1,557 1,557 237 237 Advances from FHLB 39,000 40,086 40,500 41,797 42,500 41,713
Note 14 - Earnings per share Earnings per share has been determined under the provisions of SFAS No. 128, Earnings Per Share. Basic earnings per share is computed by dividing net income applicable to common stock by the weighted average number of common shares outstanding during the period, without considering any dilutive items. Diluted earnings per share is computed by dividing net income applicable to common stock by the weighted average number of common shares and common stock equivalents for items that are dilutive, net of shares assumed to be repurchased using the treasury stock method. Common stock equivalents arise from the assumed conversion of outstanding stock options. F - 30 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 14 - Earnings per share (continued) The only potential stock of the Company as defined in SFAS No. 128, is stock options granted to various directors and officers of the Bank. The following is a summary of the computation of basic and diluted earnings per share:
Quarter Quarter Ended Ended Year Ended Year Ended Year Ended Year Ended March 31, March 31, December 31, December 31, September 31, September 31, 2002 2001 2001 2000 2000 1999 ------------- ------------- ------------ ------------ ------------- ------------- Net income $ 992 $ 512 $ 1,704 $ 1,748 $ 2,185 $ 2,161 Weighted average outstanding shares 4,097 4,083 4,085 4,089 4,118 4,294 Basic earnings per share $0.24 $ 0.13 $ 0.42 $ 0.43 $ 0.53 $ 0.50 Weighted average outstanding shares 4,097 4,083 4,085 4,089 4,118 4,294 Dilutive effect of stock options 27 - 19 - 1 14 ------ ------ ------- ------- ------- ------- Weighted average diluted shares 4,124 4,083 4,104 4,089 4,119 4,308 Diluted earnings per share $ 0.24 $ 0.13 $ 0.42 $ 0.43 $ 0.53 $ 0.50
On October 9, 1998, the Company's Board of Directors announced the authorization to repurchase up to 105 shares of outstanding common stock under the 1998 Stock Repurchase Plan. On April 19, 1999, the Company's Board of Directors announced the authorization to repurchase 295 shares of outstanding common stock for the 1999 Stock Option Plan and the 1999 Recognition and Retention Plan. On May 23, 2000, the Company's Board of Directors announced the authorization to repurchase up to 92 shares of outstanding common stock. As of March 31, 2002 and December 31, 2001, 372 shares had been repurchased under these plans at an average price of $12.61 per share. Note 15 - Parent-Only Financial Information The earnings of the Bank are recognized by Citizens South Banking Corporation using the equity method of accounting. Accordingly, undistributed earnings of the Bank are recorded as increases in the Company's investment in the Bank. The following are the condensed financial statements of the Company as of March 31, 2002, December 31, 2001 and December 31, 2000 and for the quarter ended March 31, 2002, the year ended December 31, 2001, the year ended December 31, 2000, the year ended September 30, 2000, and the year ended September 31, 1999. F - 31 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 15 - Parent-Only Financial Information (continued) Condensed Statements of Financial Condition - -------------------------------------------
March 31, December 31, December 31, 2002 2001 2000 --------- ------------ ------------ Assets - ------ Cash and cash equivalents $ 3,413 $ 1,929 $ 2,395 Investment in securities available-for-sale 878 868 949 Investment in subsidiary 37,693 38,743 36,414 Other assets 383 136 75 ------- ------- ------- Total assets $42,367 $41,676 $39,833 ======= ======= ======= Liabilities and Stockholders' Equity - ------------------------------------ Liabilities $ 130 $ 46 $ 70 Stockholders' Equity 42,237 41,630 39,763 ------- ------- ------- Total liabilities and stockholders' equity $42,367 $41,676 $39,833 ======= ======= =======
Condensed Statements of Operations - -----------------------------------
Quarter Ended Year Ended Year Ended Year Ended Year Ended March 31, December 31, December 31, September 30, September 30, 2002 2001 2000 2000 1999 ------------- --------------- -------------- ------------------------------ Interest income $ 14 $ 76 $ 109 $ 126 $ 227 Interest expense - - - - - Other operating expenses (81) (75) (93) (75) (137) ------ ------ ------ ------ ------ Income before income taxes and undistributed (67) Earnings from subsidiaries 1 17 51 90 Income taxes 30 - (7) (19) (70) ------ ------ ------ ------ ------ Income before undistributed earnings from subsidiaries (37) 1 10 32 20 Equity in undistributed earnings of Subsidiaries 1,029 1,703 1,738 2,153 2,141 ------ ------ ------ ------ ------ Net income $ 992 $1,704 $1,748 $2,185 $2,161 ====== ====== ====== ====== ======
F - 32 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 15 - Parent-Only Financial Information (continued) Condensed Statements of Cash Flows - ----------------------------------
Quarter Ended Year Ended Year Ended Year Ended Year Ended March 31, December 31, December 31, September 30, September 30, 2002 2001 2000 2000 1999 -------------- -------------- -------------- -------------- -------------- Operating activities Net income $ 992 $ 1,704 $ 1,748 $ 2,185 $ 2,161 Adjustments to reconcile net income to net Cash provided by operating activities Equity in undistributed (earnings) loss of subsidiaries (1,029) (1,703) (1,738) (2,153) (2,141) Issuance of stock for Recognition and Retention Plan - - - - 1,015 Allocation of shares to ESOP 28 283 124 124 122 Decrease (increase) in other operating assets 1,549 (62) (12) (215) 11 (Decrease) increase in other operating 9 (99) 17 (45) liabilities 84 ------- -------- ------- ------- ------- Net cash provided by (used in) operating activities 1,624 231 23 (42) 1,123 Investing activities Purchase of investments available-for-sale - - (294) (150) - Maturities and prepayments of investment - securities - - - - 1,000 Acquisition of Innes Street Financial Corp., net of cash acquired - (22,607) - - - ------- -------- ------- ------- ------- Net cash provided by (used in) investing activities - (22,607) (294) (150) 1,000 Financing activities Repurchase of common stock - (116) (897) (1,801) (2,859) Dividends received from bank subsidiary - 22,555 - - - Dividends to stockholders (140) (529) (730) (862) (938) ------- -------- ------- ------- ------- Net cash (used in) provided by financing activities (140) 21,910 (1,627) (2,663) (3,797) Net increase (decrease) in cash and cash equivalents 1,484 (466) (1,898) (2,855) (1,674) Cash and cash equivalents, beginning of period 1,929 2,395 4,293 5,199 6,874 ------- -------- ------- ------- ------- Cash and cash equivalents, end of period $ 3,413 $ 1,929 $ 2,395 $ 2,344 $ 5,200 ======= ======== ======= ======= =======
F - 33 CITIZENS SOUTH BANKING CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Continued) (in thousands, except per share amounts) Note 16 - Reorganization and Change of Corporate Form (Unaudited) The Board of Directors of the Citizens South Holdings, MHC ("the MHC"), the Company and the Bank adopted the Plan of Conversion and Reorganization (the "Plan") on May 23, 2002. Pursuant to the Plan, the MHC will convert from the mutual holding company form of organization to the fully public form. The MHC will be merged into the Bank, and the MHC will no longer exist. Pursuant to the plan, the Company, which owns 100% of the Bank, also will be succeeded by a new Delaware corporation with the same name, Citizens South Banking Corporation. As part of the conversion, shares of common stock of Citizens South Banking Corporation representing the ownership interest of the MHC will be offered for sale in the offering. The existing publicly held shares of the Company, which represents the remaining ownership interest in the Company, will be exchanged for new shares of commons stock of Citizens South Banking Corporation, the new Delaware corporation. The exchange ratio will ensure that immediately after the reorganization and the share exchange, the public stockholders of the Company will own the same aggregate percentage of Citizens South Banking Corporation common stock that they owned immediately prior to the reorganization. When the conversion is completed, all of the capital stock of the Bank will be owned by Citizens South Banking Corporation. The Plan provides for the establishment, upon the completion of the reorganization, of a special "liquidation account" for the benefit of certain depositors of the Bank in an amount equal to the greater of the MHC's ownership interest in the retained earnings of the Company as of the date of its latest balance sheet contained in the prospectus or the retained earnings of the Bank at the time it reorganized into the MHC in 1998. Following the completion of the reorganization, under the rules of the Office of Thrift Supervision, the Bank will not be permitted to pay dividends on its capital stock to Citizens South Banking Corporation, its sole stockholder, if the Bank's stockholder's equity would be reduced below the amount of the liquidation account. At December 31, 2001, the Company had incurred no costs associated with the offering. Costs that are incurred will be netted against proceeds received in the transaction. If, however, the offering is not completed, the costs associated with the offering will be expensed in the period in which the offering is terminated. F - 34 INNES STREET HISTORICAL AND PRO FORMA FINANCIAL DATA G-1 Pro Forma Financial Statements Unaudited Pro Forma Condensed Consolidated Statement of Condition
Citizens South Innes Street Banking Financial Corporation Corporation -------------- --------------- September 30, September 30, Pro Forma Pro Forma 2001 2001 Adjustments Combined -------------- --------------- ------------- ------------ (Dollars in Thousands) Assets - ------ Cash and cash equivalents .......................................... $ 32,796 $ 16,221 $ (37,852)(a) $ 11,165 Investment securities, available for sale .......................... 28,332 -- -- 28,332 Investment securities, held to maturity ............................ -- -- -- -- Mortgage-backed securities, available for sale ..................... 25,015 2,204 -- 27,219 Mortgage-backed securities, held to maturity ....................... -- 439 22 (b) 461 Loans, net ......................................................... 165,743 190,052 1,286 (b) 357,081 Premises and equipment, net ........................................ 4,857 2,119 2,566 (b) 9,542 Accrued interest receivable ........................................ 1,303 1,006 -- 2,309 Federal Home Loan Bank stock ....................................... 2,177 1,715 -- 3,892 Goodwill and other intangible assets ............................... -- -- 10,716 (b) 10,716 Other assets ....................................................... 6,375 2,892 -- 9,267 ------------ ------------ ---------- ------------ Total assets ......................................................... $ 266,598 $ 216,648 (23,262) $ 459,984 ============ ============ ========== ============ Liabilities and Equity - ---------------------- Deposits ........................................................... $ 180,155 $ 175,053 $ 1,454 (b) $ 356,662 Advances from borrowers for taxes and insurance .................... 918 464 -- 1,382 Borrowed money ..................................................... 42,158 12,000 -- 54,158 Other liabilities .................................................. 1,740 1,855 2,560 (c) 6,155 ------------ ------------ ---------- ------------ Total liabilities ............................................... 224,971 189,372 4,014 418,357 Common stock and additional paid in capital, net of ESOP loan ..... 15,211 8,597 (8,597)(d) 15,211 Retained earnings, substantially restricted ....................... 25,015 19,183 (19,183)(d) 25,015 Unrealized gain on securities available for sale, net of tax ...... 1,401 42 (42)(d 1,401 Unearned compensation MRP .......................................... -- (546) 546 (d) -- ------------ ------------ ---------- ------------ Total equity .................................................... 41,627 27,276 (27,276) 41,627 ------------ ------------ ---------- ------------ Total liabilities and equity ......................................... $ 266,598 $ 216,648 $ (23,262) $ 459,984 ============ ============ ========== ============
- -------------------------- (a) Amount reflects the use of cash to fund the merger consideration of $37.413 million, payment of transaction costs of $1.374 million, aftertax restructuring costs of $898,000, repayment of ESOP loan of $1.588 million, and tax benefit of MRPs of $245,000. (b) Amounts reflect the allocation of the purchase price based on the fair market value of assets acquired and liabilities assumed. The fair market value of investments held was estimated using quoted market values. The fair market values of loans and deposits were estimated using discounted expected future cash flows for these items based on their weighted average life and weighted average yields. The fair market value of premises and equipment was estimated based on the appraised value of significant assets. The core deposit intangible asset of $1.962 million represents the premium paid for the deposits assumed in the transaction and was estimated by discounting the spread between the Company's weighted average cost of funds and the weighted average rate paid on the liabilities of Innes Street Financial Corporation. The servicing intangible asset of $367,000 represents the excess of servicing fees over related costs of servicing the assets. The excess of the purchase price paid over the fair value of net assets of $8.387 million is reflected as goodwill. (c) Amount reflects the accrued liabilities of $1.381 million associated with the costs for employee termination benefits and other exit costs and $1.179 million in deferred tax liability as a result of the fair market value adjustments. (d) Reflects the elimination of the equity accounts of Innes Street Financial Corporation. G-2 Pro Forma Financial Statements Unaudited Pro Forma Condensed Consolidated Statement of Income
Citizens South Innes Street Banking Financial Corporation Corporation ----------------- ----------------- Nine Months Ended Nine Months Ended Pro Forma Pro Forma September 30, 2001 June 30, 2001 Adjustments Combined ------------------ ----------------- ------------------- ------------- (Dollars in Thousands, Except Per Share Data) Interest Income - --------------- Loans .............................................. $ 9,392 $ 11,238 $ (1,248) (a,b) 19,383 Investment securities .............................. 1,386 -- -- 1,386 Interest-bearing deposits .......................... 771 404 (527) (a) 649 Mortgage-backed and related securities ............. 1,127 192 -- 1,319 --------------- --------------- ------------ ------------ Total interest income ........................... 12,676 11,834 (1,775) 22,736 Interest Expense - ---------------- Deposits ........................................... 5,938 6,819 (1,249) (b) 11,508 Borrowed funds ..................................... 1,813 679 -- 2,492 --------------- --------------- ------------ ------------ Total interest expense .......................... 7,751 7,498 (1,249) 14,000 Net interest income after provision ................ 4,925 4,336 (526) 8,736 Provision for loan losses .......................... 90 27 -- 117 --------------- --------------- ------------ ------------ Net interest income after provision ............. 4,835 4,309 (526) 8,619 Noninterest Income - ------------------ Service charges on deposit accounts ................ 1,302 33 -- 1,335 Gain on sale of assets ............................. -- 97 -- 97 Other income ....................................... 853 215 (57) (b) 1,011 --------------- --------------- ------------ ------------ Total noninterest income ........................ 2,155 345 (57) 2,443 Noninterest Expense - ------------------- Compensation and benefits .......................... 2,710 1,705 -- 4,415 Occupancy and equipment expense .................... 510 424 -- 934 Loss on sale of assets ............................. 9 -- -- 9 Other expenses ..................................... 1,589 1,033 496 (b) 3,118 --------------- --------------- ------------ ------------ Total noninterest expense ....................... 4,818 3,162 496 8,476 Income before income taxes ......................... 2,172 1,492 (1,079) 2,585 Provision for income taxes ......................... 689 565 (378) (c) 876 --------------- --------------- ------------ ------------ Net income ........................................... $ 1,483 $ 927 $ (701) $ 1,709 =============== =============== ============ ============ Basic earnings per share ............................. $ 0.36 $ 0.54 $ 0.42 Diluted earnings per share ........................... $ 0.36 $ 0.53 $ 0.42 Basic weighted average outstanding shares ............ 4,080,122 1,707,684 4,080,122 Diluted weighted average outstanding shares .......... 4,091,723 1,738,085 4,091,723
G-3 Pro Forma Financial Statements Unaudited Pro Forma Condensed Consolidated Statement of Income
Citizens South Innes Street Banking Financial Corporation Corporation -------------------- ------------------ Twelve Months Twelve Months Ended Ended Pro Forma December 31, 2000 September 30, 2000 Adjustments Pro Forma Combined -------------------- ------------------ ---------------- -------------------- (Dollars in Thousands, Except Per Share Data) Interest Income - --------------- Loans ....................................... $ 13,320 $ 13,644 $ (1,597)(a,b) 25,367 Investment securities ....................... 1,890 260 -- 2,150 Interest-bearing deposits ................... 168 552 (702)(a) 18 Mortgage-backed and related securities ...... 1,455 297 -- 1,752 --------------- --------------- ------------ ---------------- Total interest income .................... 16,833 14,753 (2,299) 29,287 Interest Expense - ---------------- Deposits .................................... 7,296 8,268 (1,358)(b) 14,206 Borrowed funds .............................. 2,389 353 -- 2,742 --------------- --------------- ------------ ---------------- Total interest expense ................... 9,685 8,621 (1,358) 16,948 Net interest income after provision ......... 7,148 6,132 (941) 12,339 Provision for loan losses ................... 53 -- -- 53 --------------- --------------- ------------ ---------------- Net interest income after provision ...... 7,095 6,132 (941) 12,286 Noninterest Income - ------------------ Service charges on deposit accounts ......... 762 40 -- 802 Gain on sale of assets ...................... 271 52 -- 323 Other income ................................ 1,440 343 (76)(b) 1,707 --------------- --------------- ------------ ---------------- Total noninterest income ................. 2,473 435 (76) 2,832 Noninterest Expense - ------------------- Compensation and benefits ................... 3,725 2,500 -- 6,225 Occupancy and equipment expense ............. 612 556 -- 1,168 Loss on sale of assets ...................... 873 31 -- 904 Other expenses .............................. 1,765 1,360 662 (b) 3,787 --------------- --------------- ------------ ---------------- Total noninterest expense ............... 6,975 4,447 662 12,084 Income before income taxes .................. 2,593 2,120 (1,679) 3,034 Provision for income taxes .................. 846 789 (588) 1,047 --------------- --------------- ------------ ---------------- Net income .................................... $ 1,747 $ 1,331 $ (1,091) $ 1,987 =============== =============== ============ ================ Basic earnings per share ...................... $ 0.43 $ 0.72 $ 0.49 Diluted earnings per share .................... $ 0.43 $ 0.72 $ 0.49 Basic weighted average outstanding shares ..... 4,082,270 1,838,692 4,082,270 Diluted weighted average outstanding shares ... 4,093,871 1,847,085 4,093,871
_________________________ (a) Reflects the financing costs associated with this transaction based on the sale of $14.0 million of fixed rate mortgage loans yielding 7.5% and the use of excess interest-bearing deposits yielding 3.0%. The weighted average cost of the $37.413 million transaction is estimated to be 4.68%. (b) Amount reflects the amortization of the fair value adjustment to related assets and liabilities. The amortization periods for loans and deposits are the weighted average lives of the portfolios and amortization expenses are reflected in interest income and interest expense, respectively. The amortization periods for the fair value adjustments for premises and equipment, the servicing asset and the core deposit intangible asset are their estimated lives and the amortization expenses are reflected in other expense, other income and other expense, respectively. There is no amount representing the amortization of goodwill recognized in this transaction in accordance with Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets. (c) Amount reflects the net impact on the provision for income taxes resulting from the pro forma adjustments above, computed using an estimated effective rate of 35%. Note: Nonrecurring costs related to employee termination benefits and other exit costs reflected in the pro forma statement of condition have not been reflected in the pro forma statement of operations. G-4 Innes Street Financial Corporation Consolidated Financial Statements Years ended September 30, 2000 and 1999 Contents Report of Independent Auditors ........................................... G-6 Audited Consolidated Financial Statements Consolidated Balance Sheets .............................................. G-7 Consolidated Statements of Income ........................................ G-8 Consolidated Statements of Shareholders' Equity .......................... G-9 Consolidated Statements of Cash Flows .................................... G-10 Notes to Consolidated Financial Statements ............................... G-11
G-5 Report of Independent Auditors The Board of Directors Innes Street Financial Corporation We have audited the accompanying consolidated balance sheets of Innes Street Financial Corporation as of September 30, 2000 and 1999, and the related consolidated statements of income, shareholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Innes Street Financial Corporation at September 30, 2000 and 1999, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP November 17, 2000 G-6 Innes Street Financial Corporation Consolidated Balance Sheets
September 30 -------------------------------- 2000 1999 -------------- --------------- Assets Cash and due from banks $ 2,987,315 $ 3,667,346 Federal funds sold-overnight 6,686,000 3,122,000 -------------- --------------- Cash and cash equivalents 9,673,315 6,789,346 Investment securities available-for-sale 3,099,380 16,023,687 Investment securities held-to-maturity (fair value of $635,344 and $727,555 at September 30, 2000 and 1999, respectively) 630,476 715,216 Loans receivable, net 186,915,054 167,874,234 Premises and equipment, net 2,375,478 2,173,006 Other 5,354,619 4,425,138 Total assets -------------- --------------- $ 208,048,322 $ 198,000,627 ============== =============== Liabilities and equity Deposit accounts $ 166,406,701 $ 160,809,797 Borrowings 13,600,000 - Other 2,240,173 1,509,048 -------------- --------------- Total liabilities 182,246,874 162,318,845 Commitments and contingencies Preferred Stock, no par value: Authorized - 5,000,000 shares; none issued and outstanding - - Common stock, no par value: Authorized - 20,000,000 shares; issued and outstanding - 1,974,325 and 2,135,838 shares at September 30, 2000 and 1999, respectively - - Paid in capital 10,522,958 20,106,106 Retained earnings (substantially restricted) 18,208,565 17,251,509 Unearned compensation - ESOP stock (2,188,339) (1,708,670) Unearned compensation - Management Recognition Plan (MRP) (779,339) - Accumulated other comprehensive income 37,603 32,837 -------------- --------------- Total equity 25,801,448 35,681,782 -------------- --------------- Total liabilities and equity $ 208,048,322 $ 198,000,627 ============== ===============
See accompanying notes. G-7 Innes Street Financial Corporation Consolidated Statements of Income
Year ended September 30 -------------------------------- 2000 1999 -------------------------------- Interest and fee income: Loans receivable $ 13,643,611 $ 11,876,172 Investments 557,611 789,316 Other interest-earning assets 677,363 1,321,198 ------------- ------------ Total interest income 14,878,585 13,986,686 Interest expense: Deposits 8,267,742 7,736,427 Borrowings 352,884 430,878 ------------- ------------ Total interest expense 8,620,626 8,167,305 ------------- ------------ Net interest income 6,257,959 5,819,381 Provision for loan losses - - ------------- ------------ Net interest income after provision for loan losses 6,257,959 5,819,381 Non-interest income: Loan servicing fees 77,798 138,422 Gain on sales of loans, net 20,278 98,271 Other 140,310 96,900 ------------- ------------ Total non-interest income 238,386 333,593 Non-interest expense: Compensation and benefits 2,499,832 1,727,259 Occupancy and equipment 555,999 465,301 Advertising and promotion 220,223 133,871 Data processing 231,907 216,797 Deposit insurance premium 48,654 94,835 Other 819,523 797,816 ------------- ------------ Total non-interest expense 4,376,138 3,435,879 ------------- ------------ Income before income taxes 2,120,207 2,717,095 Provision for income taxes 789,318 1,011,841 ------------- ----------- Net income $ 1,330,889 $ 1,705,254 ============= ============ Basic and diluted earnings per share $ 0.72 $ 0.83 Basic weighted average shares outstanding 1,838,692 2,066,326 Diluted weighted average shares outstanding 1,847,085 2,066,326
See accompanying notes. G-8 Innes Street Financial Corporation Consolidated Statements of Shareholders' Equity
Unearned Unearned Shares of Deferred Compensation Compensation Common Paid in Retained Compensation Relating to the Relating to the Stock Capital Earnings Plans ESOP MRP ----------- ------------ ------------ ------------ --------------- --------------- Balance at September 30, 1998 $ 15,856,214 Net income 1,705,254 Change in unrealized appreciation on securities available for sale, net of taxes of ($53,307) Comprehensive income Dividends paid ($.15 per share) (309,959) Net proceeds from Initial Public Offering 2,248,250 $ 21,598,347 $ (1,798,600) Shares purchased and held in rabbi trusts $ 1,238,118 Deferred compensation obligation (1,238,118) Commitment of ESOP shares (8,993 shares) 25,321 89,930 Repurchase of common stock (112,412) (1,517,562) --------- ------------ ------------ ----------- ------------ ------------- Balance at September 30, 1999 2,135,838 20,106,106 17,251,509 - (1,708,670) - Net income 1,330,889 Change in unrealized appreciation on securities available for sale, net of taxes of ($2,854) Comprehensive income Dividends paid ($0.20 per share) (373,833) Return of Capital ($4.00 per share) (7,489,984) (657,088) Shares purchased and held in rabbi trusts 231,656 Deferred compensation obligation (231,656) Commitment of ESOP shares (17,514 shares) 33,723 177,419 Repurchase of common stock (251,443) (3,295,977) Issuance of MRP stock 89,930 1,169,090 $ (1,169,090) Prorata vesting of MRP stock 389,751 --------- ------------ ------------ ----------- ------------ ------------ Balance at September 30, 2000 1,974,325 $ 10,522,958 $ 18,208,565 $ - $ (2,188,339) $ (779,339) ========= ============ ============ =========== ============ ============ Accumulated Other Total Comprehensive Shareholders' Income Equity ------------- ------------- Balance at September 30, 1998 $ 116,162 $ 15,972,376 Net income 1,705,254 Change in unrealized appreciation on securities available for sale, net of taxes of ($53,307) (83,325) (83,325) ------------ Comprehensive income 1,621,929 Dividends paid ($.15 per share) (309,959) Net proceeds from Initial Public Offering 19,799,747 Shares purchased and held in rabbi trusts 1,238,118 Deferred compensation obligation (1,238,118) Commitment of ESOP shares (8,993 shares) 115,251 Repurchase of common stock (1,517,562) --------- ------------ Balance at September 30, 1999 32,837 35,681,782 Net income 1,330,889 Change in unrealized appreciation on securities available for sale, net of taxes of ($2,854) 4,766 4,766 ------------ Comprehensive income 1,335,655 Dividends paid ($0.20 per share) (373,833) Return of Capital ($4.00 per share) (8,147,072) Shares purchased and held in rabbi trusts 231,656 Deferred compensation obligation (231,656) Commitment of ESOP shares (17,514 shares) 211,142 Repurchase of common stock (3,295,977) Issuance of MRP stock - Prorata vesting of MRP stock 389,751 --------- ------------ Balance at September 30, 2000 $ 37,603 $ 25,801,448 ========= ============
See accompanying notes. G-9 Innes Street Financial Corporation Consolidated Statements of Cash Flows
Year ended September 30 ----------------------------- 2000 1999 ------------ ------------ Operating activities Net income $ 1,330,889 $ 1,705,254 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 286,950 203,923 Amortization of discount on investments (1,677) (1,771) Amortization of deferred loan fees (139,984) 47,005 Commitment of ESOP shares 211,142 115,251 Prorata vesting of MRP stock 389,751 - Deferred income taxes (83,966) (128,934) Gain on sales of loans, net (20,278) (98,271) Loss on sale of investments 24,066 - Other, net (115,255) 984,700 ------------ ------------ Net cash provided by operating activities 1,881,638 2,827,157 Investing activities Proceeds from maturity of federal funds sold-term - 2,000,000 Purchases of investments available-for-sale - (11,989,500) Proceeds from sale of available-for-sale securities 11,975,125 - Principal repayment of mortgage-backed securities 1,019,152 3,908,310 Net increase in loans (20,621,834) (10,190,843) Purchases of loans (855,846) (6,572,367) Proceeds from sales of loans 2,449,319 8,188,286 Purchase of FHLB stock (21,000) - Proceeds from redemption of FHLB stock - 218,200 Proceeds from sales of foreclosed real estate 147,803 110,516 Purchases of premises and equipment (489,555) (1,198,005) Proceeds from sales of premises and equipment 133 - ------------ ------------ Net cash used in investing activities (6,396,703) (15,525,403) Financing activities Net increase (decrease) in deposit accounts 5,596,904 (738,705) Proceeds from borrowings 20,600,000 - Repayment of borrowings (7,000,000) (10,000,000) Net increase (decrease) in mortgage escrow funds 19,012 (1,028,309) Net proceeds from issuance of common stock - 19,799,747 Repurchase of common stock (3,295,977) (1,517,562) Dividends paid (8,520,905) (309,959) ------------ ------------ Net cash provided by financing activities 7,399,034 6,205,212 ------------ ------------ Net increase (decrease) in cash and cash equivalents 2,883,969 (6,493,034) Cash and cash equivalents at beginning of year 6,789,346 13,282,380 ------------ ------------ Cash and cash equivalents at end of year $ 9,673,315 $ 6,789,346 ============ ============ Supplemental disclosure of cash flow data: Cash paid during the year for: Interest $ 8,651,145 $ 8,222,055 Taxes $ 1,005,289 $ 1,189,524 Transfers from loans to foreclosed real estate $ 107,450 $ 214,356
See accompanying notes. G-10 Innes Street Financial Corporation Notes to Consolidated Financial Statements September 30, 2000 1. Accounting Policies Basis of Presentation and Consolidation The consolidated financial statements include the accounts of Innes Street Financial Corporation and its wholly owned subsidiary, Citizens Bank, FSB (together "the Company"). All significant intercompany balances and transactions have been eliminated in consolidation. Business Innes Street Financial Corporation was incorporated on July 6, 1998 to serve as the holding company for Citizens Bank, FSB (the "Bank") upon the Bank's conversion from a federally chartered mutual savings bank to a federally chartered stock savings bank (the "Conversion"). Innes Street Financial Corporation completed the Conversion on December 28, 1998 through the sale and issuance of 2,248,250 shares of common stock. The Bank offers full service banking to those within Salisbury, North Carolina and the surrounding communities. The Office of Thrift Supervision is the Company's primary regulator. Use of Estimates In preparing consolidated financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses. Cash Equivalents Cash and cash equivalents include cash on hand, amounts due from banks, and overnight federal funds sold. The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Investment Securities Management determines the appropriate classification of securities at the time of purchase. Securities are classified as held to maturity when the Company has the positive intent and ability to hold the securities to maturity. Held to maturity securities are stated at amortized cost. Securities not classified as held to maturity are classified as available for sale. Available for sale securities are stated at fair value, with the unrealized gains and losses, net of tax, included in comprehensive income, a separate component of shareholders' equity. The amortized cost of investment securities is adjusted for amortization of premiums and accretion of discounts over the estimated life of the security. Such amortization is included in interest income from investments. The cost of securities sold is based on the specific identification method. G-11 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 1. Accounting Policies (continued) Loans Receivable The Company primarily grants mortgage loans to its customers. A substantial portion of the loan portfolio is represented by mortgage loans in Salisbury and the surrounding communities. The loans typically do not exceed 80% of the appraised value of the security property. Pursuant to underwriting guidelines adopted by the Board of Directors, the Company can lend up to 95% of the appraised value of the property securing a one-to-four family residential loan; however, the Company generally obtains private mortgage insurance on the portion of the principal amount that exceeds 80% of the appraised value of the security property. The ability of the Company's debtors to honor their contracts is dependent upon the real estate and general economic conditions of this area. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. The Company provides a reserve for uncollected interest on all nonaccrual loans. Interest income is subsequently recognized on impaired loans only to the extent cash payments in excess of past due principal amounts are received. The interest reserve is a reduction of accrued interest receivable for financial reporting purposes. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current or future payments are reasonably assured. Allowance for Loan Losses The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. Management considers the Company's loan portfolio to be homogeneous in nature; accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures. Foreclosed Real Estate Foreclosed real estate acquired in settlement of loans is carried at the lower of cost or the fair value less estimated costs to sell. Costs relating to the development and improvement of property are capitalized to the extent of the property's net realizable value, whereas those relating to holding the property are charged to expense. Real estate owned is included in Other Assets on the consolidated balance sheets. G-12 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 1. Accounting Policies (continued) Premises and Equipment Premises and equipment is stated at cost. Depreciation is computed by the straight-line method over the assets' estimated useful lives, which range from three to thirty years, for financial reporting purposes. Income Taxes The Company accounts for income taxes using the liability method in accordance with Financial Accounting Standards Board ("FASB") Statement No. 109, Accounting for Income Taxes, which requires an asset and liability approach to accounting for income taxes. Under Statement No. 109, deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Stock Compensation Plan The Company applies Accounting Principles Board Opinion No.25, Accounting for Stock Issued to Employees. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock (i.e., by intrinsic value). Stock options issued under the Company's plan have no intrinsic value, and therefore under Opinion No. 25, no compensation cost is recognized. Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (FASB 123), encourages, but does not require, adoption of a fair value method of accounting for employee stock-based compensation plans. The Company follows the pro forma disclosure provisions of FASB 123. Earnings Per Share For purposes of calculating earnings per share for the year ended September 30, 1999, the shares issued on December 28, 1998 have been assumed to be outstanding as of October 1, 1998. Segment Reporting In June 1997, the FASB issued Statement No. 131, Disclosures about Segments of an Enterprise and Related Information. This statement establishes new standards for reporting information about operating segments in annual and interim financial statements. The Company adopted this statement effective December 28, 1998, as the requirement is applicable only to publicly held corporations. Management has determined that as of September 30, 2000, it operates in only one segment, Consumer Banking. Accordingly, the financial results of the Company consist only of this one segment. Derivatives In June 1998, the FASB issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement establishes new accounting and reporting requirements for derivative instruments, including certain derivative instruments embedded in other contracts and hedging activities. Currently, the Company has no derivative instruments that fall within the definition of a derivative as defined by the statement. The Company does not anticipate that the adoption of this statement on October 1, 2000 will significantly impact the financial results of the Company. G-13 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 1. Accounting Policies (continued) In June 1999, the FASB issues Statement No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133. This statement deferred the effective date of Statement 133 to become effective for all fiscal quarters of all years beginning after June 15, 2000. As such, the Company will adopt FAS 133 on October 1, 2000. In June 2000, the FASB issued Statement No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities - an Amendment to FASB Statement No. 133. Statement 138 amends the accounting and reporting standards of Statement 133 for certain derivative instruments and certain hedging activities that caused implementation difficulties for numerous entities. Certain FASB decisions based on the recommendations of the FASB's Derivatives Implementation Group also have been incorporated into the amendment. Transfers and Servicing of Financial Assets and Extinguishment of Liabilities In September 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities (FASB 140) that replaces FASB Statement No. 125. FASB 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain additional disclosures regarding these activities. The statement is effective for transfers and servicing of financial assets or extinguishments of liabilities that occur after March 31, 2001. The statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The Company is in the process of assessing the impact and plans to adopt the standard in accordance with the effective dates. Adoption is not expected to result in a material financial impact. Reclassifications Certain prior period amounts have been reclassified to conform to the current year presentation. 2. Investment Securities The amortized cost, gross unrealized gains, gross unrealized losses and market values of investment securities are as follows:
September 30, 2000 -------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ---------- ---------- ----------- Securities Available-for Sale Mortgage-backed securities $ 3,038,118 $ 61,262 $ -- $ 3,099,380 ----------- ---------- ---------- ----------- Total securities available-for-sale $ 3,038,118 $ 61,262 $ -- $ 3,099,380 =========== ========== ========== =========== Securities Held-to-Maturity Mortgage-backed securities $ 630,476 $ 4,868 $ -- $ 635,344 ----------- ---------- ---------- ----------- Total securities held-to-maturity $ 630,476 $ 4,868 $ -- $ 635,344 =========== ========== ========== ===========
G-14 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 2. Investment Securities (continued)
September 30, 1999 --------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ----------- ---------- ----------- Securities Available-for Sale FHLB bonds and notes $11,995,180 $ - $ (38,523) $11,956,657 Mortgage-backed securities 3,974,865 92,165 - 4,067,030 ------------- ----------- ---------- ----------- Total securities available-for-sale $15,970,045 $ 92,165 $ (38,523) $16,023,687 ============= =========== ========== =========== Securities Held-to-Maturity Mortgage-backed securities $ 715,216 $ 12,339 $ - $ 727,555 ----------- ----------- ---------- ----------- Total securities held-to-maturity $ 715,216 $ 12,339 $ - $ 727,555 =========== =========== ========== ===========
The amortized cost and fair value of debt securities by contractual maturity at September 30, 2000 follows:
Available-for-Sale ------------------------------ Fair Amortized Cost Value ------------------------------ Within 1 year $ - $ - Over 1 year through 5 years 47,058 46,469 After 5 years through 10 years 75,235 77,743 Over 10 years 2,915,825 2,975,168 ------------------------------ $ 3,038,118 $ 3,099,380 ============================== Held-to-Maturity ------------------------------ Fair Amortized Cost Value ------------------------------ Within 1 year $ - $ - Over 1 year through 5 years 239,450 239,482 After 5 years through 10 years - - Over 10 years 391,026 395,862 ------------------------------ $ 630,476 $ 635,344 ==============================
Mortgage-backed securities are not due at a single maturity date. Hence, there is no contractual maturity for mortgage-backed securities as of September 30, 2000. All mortgage-backed securities are backed by FNMA, GNMA, or FHLMC. Securities carried at $1,813,309 and $1,769,854 at September 30, 2000 and 1999, respectively, were designated as security for deposits and public funds. G-15 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 3. Loans Receivable, Net Loans receivable, net consisted of the following:
September 30 --------------------------------- 2000 1999 ------------ ------------ 1-4 family $136,287,936 $134,822,329 Home equity 25,947,411 20,704,877 Construction and development 16,619,778 13,211,376 Nonresidential 6,402,796 2,386,697 Multi-family 6,125,331 3,652,435 ------------ ------------ Mortgage loans 191,383,252 174,777,714 Other loans 1,633,229 239,493 ------------ ------------ 193,016,481 175,017,207 Less: Allowance for loan losses 1,223,627 1,223,627 Loans in process 4,740,693 5,713,721 Deferred fees, net 137,107 205,625 ------------ ------------ 6,101,427 7,142,973 ------------ ------------ $186,915,054 $167,874,234 ============ ============
Mortgage loans at September 30, 2000 and 1999, are net of participations and whole loans serviced for others, in the amounts of $40,302,397 and $48,386,833, respectively. Custodial escrow balances maintained in connection with loans serviced for others were $239,285 and $292,513, at September 30, 2000 and 1999, respectively. Changes in the allowance for loan losses are summarized as follows: Year ended September 30 --------------------------- 2000 1999 ---------- ---------- Balance at beginning of year $1,223,627 $1,223,627 Provision for loan losses - - Charge-offs - - Recoveries - - ---------- ---------- Balance at end of year $1,223,627 $1,223,627 ========== ========== 4. Deposit Accounts September 30 ------------------------------------ 2000 1999 --------------- -------------- Demand $ 988,796 $ 1,086,097 NOW 5,913,759 6,572,501 Money market 3,480,141 2,014,150 Passbook savings 27,588,677 36,125,534 Certificates of deposit 128,435,328 115,011,515 --------------- -------------- Total deposits $ 166,406,701 $ 160,809,797 =============== ============== G-16 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 4. Deposit Accounts (continued) Demand deposits are non-interest bearing. All other deposit types bear interest. The aggregate amount of certificates of deposit with a minimum denomination in excess of $100,000 was $20,348,983 and $15,407,874 at September 30, 2000 and 1999, respectively. Deposits that exceed $100,000 are not federally insured. At September 30, 2000, scheduled maturities of certificates of deposit are as follows: Year ending September 30: 2001 $111,450,820 2002 14,619,070 2003 2,163,359 2004 44,026 2005 158,053 Thereafter - ------------ $128,435,328 ============ Interest expense on deposits is summarized as follows: Year ended September 30 ---------------------------- 2000 1999 ------------ ------------ NOW $ 62,197 $ 61,182 Money market 63,234 58,251 Passbook savings 1,458,629 1,519,230 Certificates of deposit 6,683,682 6,097,764 ------------ ------------ $ 8,267,742 $ 7,736,427 ============ ============ The Company had on deposit amounts from certain directors and executive officers of $1,007,035 and $933,070 as of September 30, 2000 and 1999, respectively. 5. Borrowings At September 30, 2000, the Company had outstanding borrowings of $10,000,000 with the Federal Home Loan Bank (FHLB). Pursuant to collateral agreements with FHLB, advances are secured by stock in the FHLB and qualifying first mortgage loans. The carrying value of qualifying first mortgage loans was $141,034,772 as of September 30, 2000. Interest rates on FHLB advances are fixed, and the weighted average interest rate was 6.98% at September 30, 2000. The Company had available credit with the FHLB of $40,637,400 and $39,356,000 as of September 30, 2000 and 1999, respectively. The Company also had $3,600,000 outstanding in borrowings from The Bankers Bank at September 30, 2000. The debt is collateralized by 1,000 shares (100%) of Citizens Bank stock owned by the Company. It will mature on June 15, 2001. The interest rate is prime less 50 basis points; at September 30, 2000, this was 9.00%. G-17 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 6. Employee Benefit and Deferred Compensation Plans On March 31, 1998, the Board of Directors of the Company terminated its non-contributory defined benefit pension plan effective July 31, 1998. At the time the pension plan was terminated, it was fully funded. The benefits accrued by employees under the plan have been transferred, at the election of each employee, to the Company's new 401(k) retirement plan. The Company implemented a 401(k) retirement plan effective July 1, 1998. All eligible employees may elect to contribute a percentage of their compensation to the plan each year, subject to certain maximums imposed by federal law. The Company will match 50% of each participant's contribution, up to 3% of participant's compensation. The Company will also make a contribution on behalf of the participants equal to 3% of their compensation. Participants are fully vested in the amounts they contribute to the plan. Participants will be fully vested in employer matching contributions after one year of service. Contribution expense related to this plan was $77,457 and $76,987 for the years ended September 30, 2000 and 1999, respectively. On December 28, 1998, the Company established an employee stock ownership plan (ESOP) for the benefit of all eligible employees based upon years of service with the Company. In conjunction with the establishment of the ESOP, an off-balance sheet ESOP trust was established and funded by the Company, by way of a loan to the trust, in order to purchase 179,860 shares of the Company's stock. The trust expects to pay down the loan over the fifteen-year term principally from discretionary contributions and dividends on allocated shares. An equal amount of unallocated ESOP stock was recorded as a reduction of shareholders' equity. As the ESOP trust pays down the loan, shares are allocated to participants, on the basis of relative compensation in the year of allocation, reducing the unallocated shares amount recorded in shareholders' equity. The expense associated with the ESOP, in the form of discretionary contributions and dividends on unallocated shares, was $211,771 and $142,231 for the years ended September 30, 2000 and 1999, respectively. Unallocated shares are not included in weighted average outstanding shares for purposes of computing earnings per share. As of September 30, 2000 and 1999, there were 176,808 and 176,832 weighted average uncommitted shares related to the ESOP plan. The Company maintains non-qualified deferred compensation plans for key employees and directors: a diversified and a non-diversified plan. The eligible employees may defer a portion of their compensation and the directors may defer a portion of their directors' fees. The deferred assets are maintained in rabbi trusts, which are included in Other Assets of the Company. The deferred compensation amounts directed to the diversified plans are included in Other Liabilities in the consolidated balance sheets. The assets are accounted for at market value in accordance with FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, with the resulting gains or losses in value recorded as an adjustment to the fair value of the deferred compensation obligation. The assets of the non-diversified rabbi trusts consist only of Company stock; therefore the value of the stock, at cost, and the corresponding deferred compensation have been recorded in shareholders' equity. The fair value of the assets in the rabbi trusts established for the diversified plans and the deferred compensation obligation associated with the diversified plans was $972,800 and $231,269 at September 30, 2000 and 1999, respectively. On February 2, 2000, the Company granted 89,930 shares of stock for use in a Management Recognition Plan (MRP). These shares were granted to key employees and directors. Twenty percent of these shares vested immediately and were charged to compensation expense. The remaining fair market value of the shares not vested was recorded as a reduction to shareholder's equity. This non-vested portion will vest over a 48-month period. Each month the Company records compensation expense and reduces the unearned compensation MRP. G-18 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 7. Income Taxes Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are summarized as follows.
September 30 ------------------------- 2000 1999 ----------- ----------- Deferred tax assets: Deferred compensation $ 653,357 $ 525,935 Allowance for loan losses 396,367 361,049 ESOP expense 10,662 45,343 Depreciation 10,660 32,611 Loans to facilitate sales of foreclosed real estate 28,989 30,167 Other 19,861 11,253 ----------- ----------- Total deferred tax assets 1,119,896 1,006,358 Deferred tax liabilities: Deferred fees 303,014 260,609 FHLB stock dividends 172,798 173,536 Mortgage loan servicing rights 32,089 44,754 Net unrealized appreciation on securities available-for-sale 23,659 20,805 Other 852 281 ----------- ----------- Total deferred tax liabilities 532,412 499,985 ----------- ----------- Net deferred tax asset $ 587,484 $ 506,373 =========== ===========
The following is a summary of provision for income taxes:
Year ended September 30 ------------------------- 2000 1999 ----------- ----------- Current: Federal $ 731,560 $ 999,925 State 141,721 140,850 ----------- ----------- Total current 873,281 1,140,775 Deferred: Federal (71,737) (107,073) State (12,226) (21,861) ----------- ----------- Total deferred (83,963) (128,934) ----------- ----------- $ 789,318 $ 1,011,841 =========== ===========
G-19 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 7. Income Taxes (continued) The Company's effective tax rate differs from that computed at the statutory federal income tax rate, as follows:
Year ended September 30 ------------------------- 2000 1999 ----------- ----------- Tax at statutory rate $ 720,870 $ 923,812 State income tax, net of federal income tax benefit 81,278 80,778 Other (12,830) 7,251 ----------- ----------- $ 789,318 $ 1,011,841 =========== =========== Statutory federal tax rate 34% 34% =========== =========== Effective tax rate 37% 37% =========== ===========
Savings and loan associations which met certain definitional tests and operating requirements prescribed by the Internal Revenue Code were allowed a special bad debt deduction, extended expiration dates for net operating loss carryforwards and other special tax provisions. The special bad debt deduction was based on either specified experience formulas or a specified percentage of taxable income before such deduction. The deduction was subject to certain limitations based on the aggregate loans, savings account balances and retained earnings at year end. Gains and losses on sales of repossessed property and provisions for losses on loans and real estate foreclosed were generally adjustments to the tax bad debt reserve and not included in the computation of taxable income before this deduction. Effective October 1, 1996 this deduction was no longer allowed. In addition, a portion of the tax bad debt reserve is required to be recaptured over six years. The Bank recaptured $94,488 and $93,548 into income for income tax purposes for the years ended September 30, 2000 and 1999, respectively. Retained earnings at year end include tax bad debt reserves of approximately $3,735,000, for which no provision for federal income tax has been made. If, in the future, these amounts are used for any purpose other than to absorb bad debt losses, or the Company ceases to be qualified as a savings bank, they may be subject to federal income tax at the then prevailing corporate tax rate. If federal income taxes had been provided the deferred tax liability would have been approximately $1,270,000. 8. Regulatory Matters The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory (and possibly additional discretionary) actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to adjusted assets (as defined). Management believes, as of September 30, 2000, that the Bank meets all capital adequacy requirements to which it is subject. G-20 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 8. Regulatory Matters (continued) As of September 30, 2000, the most recent notification from the Office of Thrift Supervision (OTS) categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum Tier 1 and total capital ratios as set forth in the table. The amounts and ratios as of September 30, 2000 and 1999 were set forth under the criteria established by the OTS. There are no conditions or events since that notification that management believes have changed the institution's category. (Dollars in thousands)
To Be Well Capitalized Under Prompt Minimum For Capital Corrective Action Actual Adequacy Purposes Provisions ------------------- ------------------- ---------------------- Ratio Amount Ratio Amount Ratio Amount ------------------- ------------------- ---------------------- As of September 30, 2000: Equity and ratio to total assets 11.57% $ 24,283 Unrealized appreciation of securities available for sale (38) -------- Tier 1 (Core) and ratio to adjusted total assets 11.56% $ 24,245 4.00% $ 8,390 5.00% $10,488 ======== ======= ======= Tier 1 (Core) and ratio to risk-weighted assets 18.82% $ 24,245 4.00% $ 5,154 6.00% $ 7,731 ======= ======= Allowance for loan losses 1,224 -------- Total Risk-Based Capital and ratio to risk-weighted assets 19.77% $ 25,469 8.00% $10,307 10.00% $12,884 ======== ======= ======= Total assets $209,816 ======== Adjusted total assets $209,755 ======== Risk-weighted assets $128,843 ========
G-21 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 8. Regulatory Matters (continued) (Dollars in thousands)
To Be Well Capitalized Under Minimum For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ------------------- ------------------- ---------------------- Ratio Amount Ratio Amount Ratio Amount ------------------- ------------------- ---------------------- As of September 30, 1999: Equity and ratio to total assets 14.01% $ 26,956 Unrealized appreciation of securities available for sale (49) -------- Tier 1 (Core) and ratio to adjusted total assets 13.99% $ 26,907 4.00% $ 7,694 5.00% $ 9,618 ======== ======= ======= Tier 1 (Core) and ratio to risk-weighted assets 24.32% $ 26,907 4.00% $ 4,426 6.00% $ 6,639 ======= ======= Allowance for loan losses 1,224 -------- Total Risk-Based Capital and ratio to risk-weighted assets 25.42% $ 28,131 8.00% $ 8,852 10.00% $11,065 ======== ======= ======= Total assets $192,436 ======== Adjusted total assets $192,355 ======== Risk-weighted assets $110,647 ========
The OTS places certain restrictions on dividends paid by the Bank to the Company. The total amount of dividends, which may be paid at any date, is generally limited to the retained earnings of the Bank. In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Bank's capital to be reduced below applicable minimum capital requirements. 9. Other Non-interest Expense Other non-interest expense amounts are summarized as follows: Year ended September 30 ----------------------- 2000 1999 -------- -------- Printing, postage and supplies $165,381 $156,113 Professional and legal fees 282,718 245,115 Insurance premiums 37,681 35,131 Telephone 52,881 60,142 Other 280,862 301,315 -------- -------- $819,523 $797,816 ======== ======== G-22 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 10. Commitments and Contingencies In conjunction with its lending activities, the Company enters into various commitments to extend credit. Loan commitments (unfunded loans and unused lines of credit) are issued to accommodate the financing needs of the Bank's customers. Loan commitments are agreements by the Company to lend at a future date, so long as there are no violations of any conditions established in the agreement. Financial instruments (primarily equity lines), where the contract amount represents the Company's credit risk included unused lines of credit of $20,242,938 and $17,499,579 at September 30, 2000 and 1999, respectively. These loan commitments are subject to the same credit policies and reviews as loans on the balance sheets. Collateral, both the amount and nature, is obtained based upon management's assessment of the credit risk. Since many of the extensions of credit are expected to expire without being drawn, the total commitment amounts do not necessarily represent future cash requirements. Outstanding commitments on mortgage loans not yet closed amounted to $2,828,225 and $3,374,375 at September 30, 2000 and 1999, respectively. Approximately 23% and 47% of these commitments were at fixed interest rates as of September 30, 2000 and 1999, respectively. The fixed rates ranged from 7.625% to 10.00% and 6.597% to 9.00% at September 30, 2000 and 1999, respectively. Such commitments, which are funded subject to certain limitations, extend over varying periods of time with the majority being funded within a six-month period. 11. 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 of expected cash flows or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rates 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. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The fair value estimates presented herein are based on pertinent information available to management. Such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: Investment Securities Fair values for investment securities are based on quoted market prices. For purposes of determining the fair value of Federal Home Loan Bank stock, for which quoted market prices are not available, the carrying amount of the stock has been considered the fair value. Loans Receivable The fair value of all categories of loans is estimated by discounting their expected future cash flows using interest rates currently being offered for loans with similar terms, reduced by an estimate of credit losses inherent in the portfolio. G-23 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 11. Fair Value of Financial Instruments (continued) Deposit Accounts The fair value of demand deposits (e.g., interest and non-interest bearing and money market accounts) is assumed to be their carrying amount. The fair value of savings certificates is estimated using a discounted cash flow calculation that applies rates currently being offered on instruments with similar remaining maturities. Borrowings The fair value of advances from the Federal Home Loan Bank and the Banker's Bank are estimated using discounted cash flow analysis based upon rates currently available to the Company on similar instruments. Off-Balance Sheet Instruments Fair values of the Company's commitments to extend credit and stand-by letters of credit are nominal since they have short maturities, and the committed rates approximate current rates offered for commitments with similar rate and maturity characteristics. Many of the Company's assets and liabilities are short-term financial instruments whose carrying amounts reported in the balance sheets approximate fair value. These items include cash and due from banks, accrued interest receivable and the financial instruments included in other assets and liabilities. The estimated fair values of the Company's remaining on-balance sheet financial instruments are summarized as follows:
September 30, 2000 --------------------------- Carrying Estimated Value Fair Value ------------ ------------ Financial assets: Investment securities available-for-sale $ 3,099,380 $ 3,099,380 Investment securities held-to-maturity 630,476 635,344 Loans receivable 186,915,054 187,560,000 Federal Home Loan Bank stock 1,627,600 1,627,600 Financial liabilities: Deposit accounts 166,406,701 164,409,000 Borrowings 13,600,000 13,603,000 September 30, 1999 --------------------------- Carrying Estimated Value Fair Value ------------ ------------ Financial assets: Investment securities available-for-sale $ 16,023,687 $ 16,023,687 Investment securities held-to-maturity 715,216 727,555 Loans receivable 167,874,234 165,405,414 Federal Home Loan Bank stock 1,606,600 1,606,600 Financial liabilities: Deposit accounts $160,809,797 $157,735,000
G-24 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 11. Fair Value of Financial Instruments (continued) Statement No. 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. 12. Stock Incentive Plan On February 1, 2000, the Company began an active stock option plan (the "Plan"). The Company's Plan provides for the granting of options or awards for the purchase or issuance of 224,825 shares at 100% of the fair market value of the stock at the date of the grant. This amount was based on 10% of the number of shares issued during the Conversion. The Company can also, at its discretion, purchase shares on the open market for issuance in the Plan. The shares granted in the Plan vest after a period of four years, but not to exceed 10 years from the original grant date. At September 30, 2000, the Company had 152,881 shares granted at a weighted average price of $9.28. No shares had vested; therefore no shares have been exercised, forfeited, or expired. The following table reflects pro forma net income and earnings per share had the Company elected to adopt the fair value approach of FAS 123. 2000 ----------- Net income: As reported $ 1,330,889 Pro forma $ 1,283,329 Basic earnings per share: As reported $ 0.72 Pro forma $ 0.70 The weighted average fair value of options at their grant date during 2000 was $3.06. The fair value was estimated at grant date using a Black-Scholes option pricing model with the following weighted-average assumptions for 2000: risk-free interest rate of 6.30%; volatility factor of the expected market price of the stock of 19.8%; and an expected life of the options before exercise of 4.00 years. The dividend yield was assumed to be 2.00%. G-25 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 13. Condensed Financial Statements of Parent Company The following condensed financial information pertains only to Innes Street Financial Corporation. The parent company commenced operations December 28, 1998. Condensed Balance Sheets
September 30 ---------------------------------- 2000 1999 ------------- -------------- Assets Cash and cash equivalents $ 763,900 $ 1,502,728 Investment securities available-for-sale - 6,970,717 Investment in subsidiary 29,311,736 28,194,721 Other 1,920,308 1,953,906 ------------- ------------- Total assets $ 31,995,944 $ 38,622,072 ============= ============= Liabilities and equity Accrued liabilities 92,546 160,202 Borrowings 3,600,000 - Other 2,501,950 2,780,088 Shareholders' equity 25,801,448 35,681,782 ------------- ------------- Total liabilities and equity $ 31,995,944 $ 38,622,072 ============= =============
Condensed Statements of Income
Period from December 28, Year Ended 1998, to September 30, September 30, 2000 1999 ------------- -------------- Income: Dividends from subsidiary $ 315,423 $ 337,238 Investments 158,451 208,352 Other 280,149 249,056 ------------- -------------- Total income 754,023 794,646 Operating expenses 274,046 103,017 ------------- -------------- Income before income taxes and equity in undistributed net income of subsidiary 479,977 691,629 Provision for income taxes 46,281 137,450 ------------- -------------- Equity in undistributed net income of subsidiary 897,193 1,151,075 ------------- -------------- Net income $ 1,330,889 $ 1,705,254 ============= ==============
G-26 Innes Street Financial Corporation Notes to Consolidated Financial Statements (continued) 13. Condensed Financial Statements of Parent Company (continued) Condensed Statements of Cash Flows
Period from December 28, Year Ended 1998 to September 30, September 30, 2000 1999 --------------- --------------- Operating activities Net income $ 1,330,889 $ 1,705,254 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Equity in undistributed net income of subsidiary (897,193) (1,151,075) Commitment of ESOP shares 211,142 115,251 Prorata vesting of MRP stock 389,751 - Decrease (increase) in other assets 35,407 (1,946,475) (Decrease) increase in accrued liabilities (67,656) 160,202 (Decrease) increase in other liabilities (278,138) 981,487 Loss on sale of investments 24,066 - Other, net 18,210 - ------------ ------------ Net cash provided by (used in) operating activities 766,478 (135,356) ------------ ------------ Investing activities Purchase of Bank common stock - (9,899,874) Purchases of investment securities - (6,994,750) Sale of investment securities 6,943,232 - ------------ ------------ Net cash provided by (used in) investing activities 6,943,232 (16,894,624) ------------ ------------ Financing activities Net proceeds from issuance of common stock - 21,598,347 Proceeds from borrowings 3,600,000 - Return of capital dividend (8,147,072) - Repurchase of common stock (3,295,977) (1,517,562) Purchase of common stock held by rabbi trust (231,656) (1,238,118) Dividends paid (373,833) (309,959) ------------ ------------ Net cash (used in) provided by financing activities (8,448,538) 18,532,708 ------------ ------------ Net (decrease) increase in cash and cash equivalents (738,828) 1,502,728 Cash and cash equivalents at beginning of period 1,502,728 - ------------ ------------ Cash and cash equivalents at end of period $ 763,900 $ 1,502,728 ============ ============
G-27 ________________________________________________________________________________ No person has been authorized to give any information or to make any representation other than as contained in this prospectus and, if given or made, such other information or representation must not be relied upon as having been authorized by Citizens South Banking Corporation or Citizens South Bank. This prospectus does not constitute an offer to sell or a solicitation of an offer to buy any of the securities offered hereby to any person in any jurisdiction in which such offer or solicitation is not authorized or in which the person making such offer or solicitation is not qualified to do so, or to any person whom it is unlawful to make such offer or solicitation in such jurisdiction. Neither the delivery of this prospectus nor any sale hereunder shall under any circumstances create any implication that there has been no change in the affairs of Citizens South Banking Corporation or Citizens South Bank since any of the dates as of which information is furnished herein or since the date hereof. Up to 4,600,000 Shares (Anticipated Maximum) Citizens South Banking Corporation (Holding Company for Citizens South Bank) COMMON STOCK Par Value $0.01 per share __________________ PROSPECTUS __________________ Keefe, Bruyette & Woods, Inc. August __, 2002 ________________ These securities are not deposits or accounts and are not federally insured or guaranteed. ________________ Until September __, 2002 or 25 days after commencement of the Syndicated Community Offering, if any, whichever is later, all dealers effecting transactions in the registered securities, whether or not participating in this distribution, may be required to deliver a prospectus when acting as underwriters and with respect to their unsold allotments of subscriptions. ________________________________________________________________________________ PART II: INFORMATION NOT REQUIRED IN PROSPECTUS Item 14. Indemnification of Directors and Officers Article TENTH of the Certificate of Incorporation of Citizens South Banking Corporation (the "Corporation") sets forth circumstances under which directors, officers, employees and agents of the Corporation may be insured or indemnified against liability which they incur in their capacities as such: TENTH: A. Each person who was or is made a party or is threatened to be made a party to or is otherwise involved in any action, suit or proceeding, whether civil, criminal, administrative or investigative (hereinafter a "proceeding"), by reason of the fact that he or she is or was a Director or an Officer of the Corporation or is or was serving at the request of the Corporation as a Director, Officer, employee or agent of another corporation or of a partnership, joint venture, trust or other enterprise, including service with respect to an employee benefit plan (hereinafter an "indemnitee"), whether the basis of such proceeding is alleged action in an official capacity as a Director, Officer, employee or agent or in any other capacity while serving as a Director, Officer, employee or agent, shall be indemnified and held harmless by the Corporation to the fullest extent authorized by the Delaware General Corporation Law, as the same exists or may hereafter be amended (but, in the case of any such amendment, only to the extent that such amendment permits the Corporation to provide broader indemnification rights than such law permitted the Corporation to provide prior to such amendment), against all expense, liability and loss (including attorneys' fees, judgments, fines, ERISA excise taxes or penalties and amounts paid in settlement) reasonably incurred or suffered by such indemnitee in connection therewith; provided, however, that, except as provided in Section C hereof with respect to proceedings to enforce rights to indemnification, the Corporation shall indemnify any such indemnitee in connection with a proceeding (or part thereof) initiated by such indemnitee only if such proceeding (or part thereof) was authorized by the Board of Directors of the Corporation. B. The right to indemnification conferred in Section A of this Article TENTH shall include the right to be paid by the Corporation the expenses incurred in defending any such proceeding in advance of its final disposition (hereinafter an "advancement of expenses"); provided, however, that, if the Delaware General Corporation Law requires, an advancement of expenses incurred by an indemnitee in his or her capacity as a Director or Officer (and not in any other capacity in which service was or is rendered by such indemnitee, including, without limitation, service to an employee benefit plan) shall be made only upon delivery to the Corporation of an undertaking (hereinafter an "undertaking"), by or on behalf of such indemnitee, to repay all amounts so advanced if it shall ultimately be determined by final judicial decision from which there is no further right to appeal (hereinafter a "final adjudication") that such indemnitee is not entitled to be indemnified for such expenses under this Section or otherwise. The rights to indemnification and to the advancement of expenses conferred in Sections A and B of this Article TENTH shall be contract rights and such rights shall continue as to an indemnitee who has ceased to be a Director, Officer, employee or agent and shall inure to the benefit of the indemnitee's heirs, executors and administrators. C. If a claim under Section A or B of this Article TENTH is not paid in full by the Corporation within sixty days after a written claim has been received by the Corporation, except in the case of a claim for an advancement of expenses, in which case the applicable period shall be twenty days, the indemnitee may at any time thereafter bring suit against the Corporation to recover the unpaid amount of the claim. If successful in whole or in part in any such suit, or in a suit brought by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking, the indemnitee shall be entitled to be paid also the expense of prosecuting or defending such suit. In (i) any suit brought by the indemnitee to enforce a right to indemnification hereunder (but not in a suit brought by the indemnitee to enforce a right to an advancement of expenses) it shall be a defense that, and (ii) in any suit by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking the Corporation shall be entitled to recover such expenses upon a final adjudication that, the indemnitee has not met any applicable standard for indemnification set forth in the Delaware General Corporation Law. Neither the failure of the Corporation (including its Board of Directors, independent legal counsel, or its stockholders) to have made a determination prior to the commencement of such suit that indemnification of the indemnitee is proper in the circumstances because the indemnitee has met the applicable standard of conduct set forth in the Delaware General Corporation Law, nor an actual determination by the Corporation (including its Board of Directors, independent legal counsel, or its stockholders) that the indemnitee has not met such applicable standard of conduct, shall create a presumption that the indemnitee has not met the applicable standard of conduct or, in the case of such a suit brought by the indemnitee, be a defense to such suit. In any suit brought by the indemnitee to enforce a right to indemnification or to an advancement of expenses hereunder, or by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking, the burden of proving that the indemnitee is not entitled to be indemnified, or to such advancement of expenses, under this Article TENTH or otherwise shall be on the Corporation. D. The rights to indemnification and to the advancement of expenses conferred in this Article TENTH shall not be exclusive of any other right which any person may have or hereafter acquire under any statute, the Corporation's Certificate of Incorporation, Bylaws, agreement, vote of stockholders or disinterested Directors or otherwise. E. The Corporation may maintain insurance, at its expense, to protect itself and any Director, Officer, employee or agent of the Corporation or another corporation, partnership, joint venture, trust or other enterprise against any expense, liability or loss, whether or not the Corporation would have the power to indemnify such person against such expense, liability or loss under the Delaware General Corporation Law. F. The Corporation may, to the extent authorized from time to time by the Board of Directors, grant rights to indemnification and to the advancement of expenses to any employee or agent of the Corporation to the fullest extent of the provisions of this Article TENTH with respect to the indemnification and advancement of expenses of Directors and Officers of the Corporation. Item 14. Other Expenses of Issuance and Distribution
Amount ------ * Legal Fees and Expenses ............................. $ 215,000 * Printing, Postage, Mailing and EDGAR ................ 105,000 * Appraisal and Business Plan Fees and Expenses ....... 50,000 * Accounting Fees and Expenses ........................ 77,000 * Conversion Agent and Data Processing Fees ........... 30,000 ** Marketing Agent Fees and Expenses ................... 555,000 * Marketing Agent Counsel Fees and expenses ........... 35,000 * Filing Fees (OTS, NASD, Nasdaq and SEC) ............. 44,553 * Other ............................................... 13,447 -------------- * Total ............................................... $ 1,125,000 ==============
___________________ * Estimated ** Citizens South Banking Corporation has retained Keefe, Bruyette & Woods, Inc. to assist in the sale of common stock on a best efforts basis in the Offerings. Fees are estimated at the midpoint of the offering range. Item 15. Recent Sales of Unregistered Securities Not Applicable. Item 16. Exhibits and Financial Statement Schedules: The exhibits and financial statement schedules filed as part of this registration statement are as follows: (a) List of Exhibits 1.1 Engagement Letter between the Registrant and Keefe, Bruyette & Woods, Inc. 1.2 Form of Agency Agreement between the Registrant and Keefe, Bruyette & Woods, Inc. 2 Plan of Conversion and Reorganization 3.1 Certificate of Incorporation of Citizens South Banking Corporation (Included in Exhibit 2) 3.2 Bylaws of Citizens South Banking Corporation (Included in Exhibit 2) 4 Form of Common Stock Certificate of Citizens South Banking Corporation 5 Opinion of Luse Gorman Pomerenk & Schick regarding legality of securities being registered 8.1 Federal Tax Opinion of Luse Gorman Pomerenk & Schick* 8.2 Opinion of RP Financial, LC. with respect to Subscription Rights 10.1 Employment Agreement with Kim S. Price** 10.2 Deferred Compensation and Income Continuation Agreement ** 10.3 Employee Stock Ownership Plan ** 10.4 Supplemental Executive Retirement Plan ** 21 Subsidiaries of Registrant 23.1 Consent of Luse Gorman Pomerenk & Schick (contained in Opinions included as Exhibits 5 and 8.1) 23.2 Consent of Cherry, Bekaert & Holland, L.L.P. 23.3 Consent of RP Financial, LC. 23.4 Consent of Ernst & Young LLP 24 Power of Attorney (set forth on signature page) 99.1 Appraisal Agreement between the Registrant and RP Financial, LC. 99.2 Appraisal Report of RP Financial, LC.*** 99.3 Marketing Materials* 99.4 Order and Acknowledgment Form* 99.5 Business Plan Agreement between the Registrant and RP Financial, LC. 99.6 Special Meeting Proxy Statement ______________________ * To be filed supplementally or by amendment. ** Incorporated by reference to the Registration Statement on Form SB-2 (File No. 333-42951), originally filed with the Commission on December 22, 1997. *** Supporting financial schedules filed pursuant to Rule 202 of Regulation S-T. (b) Financial Statement Schedules No financial statement schedules are filed because the required information is not applicable or is included in the consolidated financial statements or related notes. Item 17. Undertakings The undersigned Registrant hereby undertakes: (1) To file, during any period in which it offers or sells securities, a post-effective amendment to this registration statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii)To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any duration from the low or high and of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20 percent change in the maximum aggregate offering price set forth in the "Calculation of Registration Fee" table in the effective registration statement; (iii) To include any additional or changed material information on the plan of distribution. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities that remain unsold at the end of the offering. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the small business issuer pursuant to the foregoing provisions, or otherwise, the small business issuer has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act, and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the small business issuer of expenses incurred or paid by a director, officer or controlling person of the small business issuer in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the small business issuer will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the questions whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Gastonia, State of North Carolina on June 27, 2002. Citizens South Banking Corporation By: /s/ Kim S. Price ------------------------------------- Kim S. Price President and Chief Executive Officer (Duly Authorized Representative) POWER OF ATTORNEY We, the undersigned directors and officers of Citizens South Banking Corporation (the "Company") hereby severally constitute and appoint Kim S. Price as our true and lawful attorney and agent, to do any and all things in our names in the capacities indicated below which said Kim S. Price may deem necessary or advisable to enable the Company to comply with the Securities Act of 1933, and any rules, regulations and requirements of the Securities and Exchange Commission, in connection with the registration statement on Form S-1 relating to the offering of the Company's Common Stock, including specifically, but not limited to, power and authority to sign for us in our names in the capacities indicated below the registration statement and any and all amendments (including post-effective amendments) thereto; and we hereby approve, ratify and confirm all that said Kim S. Price shall do or cause to be done by virtue thereof. In accordance with the requirements of the Securities Act of 1933, this registration statement has been signed below by the following persons in the capacities and on the dates stated.
Signatures Title Date ---------- ----- ---- /s/ Kim S. Price President, Chief Executive June 27, 2002 - -------------------------------- Kim S. Price Officer and Director (Principal Executive Officer) /s/ Gary F. Hoskins Senior Vice President, Treasurer June 27, 2002 - -------------------------------- Gary F. Hoskins and Chief Financial Officer (Principal Financial and Accounting Officer) /s/ David W. Hoyle Chairman June 27, 2002 - -------------------------------- David W. Hoyle /s/ Ben Rudisill, II Vice Chairman June 27, 2002 - -------------------------------- Ben Rudisill, II /s/ Martha B. Beal Director June 27, 2002 - -------------------------------- Martha B. Beal
/s/ Ronald E. Bostian Director June 27, 2002 - ------------------------------- Ronald E. Bostian /s/ James J. Fuller Director June 27, 2002 - ------------------------------- James J. Fuller /s/ Charles D. Massey Director June 27, 2002 - ------------------------------- Charles D. Massey /s/ Eugene R. Matthews, II Director June 27, 2002 - ------------------------------- Eugene R. Matthews, II As filed with the Securities and Exchange Commission on June 28, 2002 Registration No. 333-________ ================================================================================ --------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------------------------- EXHIBITS TO REGISTRATION STATEMENT ON FORM S-1 Citizens South Banking Corporation Gastonia, North Carolina ================================================================================ EXHIBIT INDEX 1.1 Engagement Letter between the Registrant and Keefe, Bruyette & Woods, Inc. 1.2 Form of Agency Agreement between the Registrant and Keefe, Bruyette & Woods, Inc. 2 Plan of Conversion and Reorganization 3.1 Certificate of Incorporation of Citizens South Banking Corporation (Included in Exhibit 2) 3.2 Bylaws of Citizens South Banking Corporation (Included in Exhibit 2) 4 Form of Common Stock Certificate of Citizens South Banking Corporation 5 Opinion of Luse Gorman Pomerenk & Schick regarding legality of securities being registered 8.1 Federal Tax Opinion of Luse Gorman Pomerenk & Schick* 8.2 Opinion of RP Financial, LC. with respect to Subscription Rights 10.1 Employment Agreement with Kim S. Price** 10.2 Deferred Compensation and Income Continuation Agreement ** 10.3 Employee Stock Ownership Plan ** 10.4 Supplemental Executive Retirement Plan ** 21 Subsidiaries of Registrant 23.1 Consent of Luse Gorman Pomerenk & Schick (contained in Opinions included as Exhibits 5 and 8.1) 23.2 Consent of Cherry, Bekaert & Holland, L.L.P. 23.3 Consent of RP Financial, LC. 23.4 Consent of Ernst & Young LLP 24 Power of Attorney (set forth on signature page) 99.1 Appraisal Agreement between the Registrant and RP Financial, LC. 99.2 Appraisal Report of RP Financial, LC.*** 99.3 Marketing Materials* 99.4 Order and Acknowledgment Form* 99.5 Business Plan Agreement between the Registrant and RP Financial, LC. 99.6 Special Meeting Proxy Statement - ----------------------- * To be filed supplementally or by amendment. ** Incorporated by reference to the Registration Statement on Form SB-2 (File No. 333-42951), originally filed with the Commission on December 22, 1997. *** Supporting financial schedules filed pursuant to Rule 202 of Regulation S-T. EX-1.1 3 dex11.txt EXHIBIT 1.1 EXHIBIT 1.1 May 23, 2002 Mr. Kim S. Price President and CEO Citizens South Banking Corporation 245 W Main Avenue Gastonia, NC 28052 Dear Mr. Price: This proposal is in connection with Citizens South Banking Corporation, ("CSBC") intention to have the mutual holding company component of its organization reorganize from a mutual to a capital stock form of organization (the "Conversion"). In order to effect the Conversion, it is contemplated that all of CSBC's common stock to be outstanding pursuant to the Conversion will be issued to a holding company (the "Company") to be formed by CSBC, and that the Company will offer and sell shares of its common stock first to eligible persons (pursuant to CSBC's Plan of Conversion) in a Subscription and Community Offering. Keefe, Bruyette & Woods, Inc. ("KBW") will act as CSBC's and the Company's exclusive financial advisor and marketing agent in connection with the Conversion. This letter sets forth selected terms and conditions of our engagement. 1. Advisory/Conversion Services. As CSBC's and Company's financial advisor and marketing agent, KBW will provide CSBC and the Company with a comprehensive program of conversion services designed to promote an orderly, efficient, cost-effective and long-term stock distribution. KBW will provide financial and logistical advice to CSBC and the Company concerning the offering and related issues. KBW will assist in providing conversion enhancement services intended to meet the directors' objectives in the Subscription Offering and to residents of CSBC's market area, if necessary, in the Community Offering. KBW shall provide financial advisory services to CSBC which are typical in connection with an equity offering and include, but are not limited to, overall financial analysis of the client with a focus on identifying factors which impact the valuation of the common stock and provide the appropriate recommendations for the betterment of the equity valuation. Mr. Kim S. Price May 23, 2002 Page 2 of 5 Additionally, post conversion financial advisory services will include advice on shareholder relations, NASDAQ listing, dividend policy (for both regular and special dividends), stock repurchase strategy and communication with market makers. Prior to the closing of the offering, KBW shall furnish to client a Post-Conversion reference manual which will include specifics relative to these items. (The nature of the services to be provided by KBW as CSBC's and the Company's financial advisor and marketing agent are further described in Exhibit A attached hereto.) 2. Preparation of Offering Documents. CSBC, the Company and their counsel will draft the Registration Statement, Application for Conversion, Prospectus and other documents to be used in connection with the Conversion. KBW will attend meetings to review these documents and advise you on their form and content. KBW and its counsel will draft appropriate agency agreement and related documents as well as marketing materials other than the Prospectus. 3. Due Diligence Review. Prior to filing the Registration Statement, Application for Conversion or any offering or other documents naming KBW as CSBC's and the Company's financial advisor and marketing agent, KBW and their representatives will undertake substantial investigations to learn about CSBC's business and operations ("due diligence review") in order to confirm information provided to us and to evaluate information to be contained in CSBC's and/or the Company's offering documents. CSBC agrees that it will make available to KBW all relevant information, whether or not publicly available, which KBW reasonably requests, and will permit KBW to discuss with management the operations and prospects of CSBC. KBW will treat all material non-public information as confidential. CSBC acknowledges that KBW will rely upon the accuracy and completeness of all information received from CSBC, its officers, directors, employees, agents and representatives, accountants and counsel including this letter to serve as CSBC's and the Company's financial advisor and marketing agent. 4. Regulatory Filings. CSBC and/or the Company will cause appropriate offering documents to be filed with all regulatory agencies including, the Securities and Exchange Commission ("SEC""), the National Association of Securities Dealers ("NASD"), Office of Thrift Supervision ("OTS") and such state securities commissioners as may be determined by CSBC. 5. Agency Agreement. The specific terms of the conversion services, conversion offering enhancement and syndicated offering services contemplated in this letter shall be set forth in an Agency Agreement between KBW and CSBC and the Company to be executed prior to commencement of the offering, and dated the date that the Company's Prospectus is declared effective and/or authorized to be disseminated by the appropriate regulatory agencies, the SEC, the NASD, the OTS and such state securities commissioners and other regulatory agencies as required by applicable law. Mr. Kim S. Price May 23, 2002 Page 3 of 5 6. Representations, Warranties and Covenants. The Agency Agreement will provide for customary representations, warranties and covenants by CSBC and KBW, and for the Company to indemnify KBW and their controlling persons (and, if applicable, the members of the selling group and Mr. Kim S. Price May 23, 2002 Page 3 of 5their controlling persons), and for KBW to indemnify CSBC and the Company against certain liabilities, including, without limitation, liabilities under the Securities Act of 1933. 7. Fees. For the services hereunder, CSBC and/or Company shall pay the following fees to KBW at closing unless stated otherwise: (a) A Management Fee of $50,000 payable in four consecutive monthly installments of $12,500 commencing with the signing of this letter. Such fees shall be deemed to have been earned when due. Should the Conversion be terminated for any reason not attributable to the action or inaction of KBW, KBW shall have earned and be entitled to be paid fees accruing through the stage at which point the termination occurred. This Management Fee shall be applied against the Success Fee described below. (b) A Success Fee of 1.35% of the aggregate Purchase Price of Common Stock sold in the Subscription Offering and Community Offering excluding shares purchased by CSBC's officers, directors, or employees (or members of their immediate families) plus any ESOP, tax-qualified or stock based compensation plans (except IRA's) or similar plan created by CSBC for some or all of its directors or employees. The Success Fee shall be reduced by the Management Fee described in (a) above. (c) If any shares of the Company's stock remain available after the subscription offering, at the request of CSBC, KBW will seek to form a syndicate of registered broker-dealers to assist in the sale of such common stock on a best efforts basis, subject to the terms and conditions set forth in the selected dealers agreement. KBW will endeavor to distribute the common stock among dealers in a fashion which best meets the distribution objectives of CSBC and the Plan of Conversion. KBW will be paid a fee not to exceed 5.5% of the aggregate Purchase Price of the shares of common stock sold by them. KBW will pass onto selected broker-dealers, who assist in the syndicated community, an amount competitive with gross underwriting discounts charged at such time for comparable amounts of stock sold at a comparable price per share in a similar market environment. Fees with respect to purchases affected with the assistance of a broker/dealer other than KBW shall be transmitted by KBW to such broker/dealer. The decision to utilize selected broker-dealers will be made by CSBC upon consultation with KBW. In the event, with respect to any stock purchases, fees are paid pursuant to this subparagraph 7(c), such fees shall be in lieu of, and not in addition to, payment pursuant to subparagraph 7(a) and 7(b). Mr. Kim S. Price May 23, 2002 Page 4 of 5 8. Additional Services. KBW further agrees to provide financial advisory assistance to the Company and CSBC for a period of one year following completion of the Conversion, including formation of a dividend policy and share repurchase program, assistance with shareholder reporting and shareholder relations matters, general advice on mergers and acquisitions and Mr. Kim S. Price May 23, 2002 Page 4 of 5 other related financial matters, without the payment by the Company and CSBC of any fees in addition to those set forth in Section 7 hereof. Nothing in this Agreement shall require the Company and CSBC to obtain such services from KBW. Following this initial one year term, if both parties wish to continue the relationship, a fee will be negotiated and an agreement entered into at that time. 9. Expenses. CSBC will bear those expenses of the proposed offering customarily borne by issuers, including, without limitation, regulatory filing fees, SEC, "Blue Sky," and NASD filing and registration fees; the fees of CSBC's accountants, attorneys, appraiser, transfer agent and registrar, printing, mailing and marketing and syndicate expenses associated with the Conversion; the fees set forth in Section 7; and fees for "Blue Sky" legal work. If KBW incurs expenses on behalf of Client, Client will reimburse KBW for such expenses. KBW's reasonable out-of-pocket expenses, including costs of travel, meals and lodging, photocopying, telephone, facsimile and couriers, not to exceed $15,000, and reasonable fees and expenses of counsel not to exceed $35,000. The selection of such counsel will be done by KBW, with the approval of CSBC. 10. Conditions. KBW's willingness and obligation to proceed hereunder shall be subject to, among other things, satisfaction of the following conditions in KBW's opinion, which opinion shall have been formed in good faith by KBW after reasonable determination and consideration of all relevant factors: (a) full and satisfactory disclosure of all relevant material, financial and other information in the disclosure documents and a determination by KBW, in its sole discretion, that the sale of stock on the terms proposed is reasonable given such disclosures; (b) no material adverse change in the condition or operations of CSBC subsequent to the execution of the agreement; and (c) no adverse market conditions at the time of offering which in KBW's opinion make the sale of the shares by the Company inadvisable. 11. Benefit. This Agreement shall inure to the benefit of the parties hereto and their respective successors and to the parties indemnified pursuant to the terms and conditions of the Agency Agreement and their successors, and the obligations and liabilities assumed hereunder by the parties hereto shall be binding upon their respective successors provided, however, that this Agreement shall not be assignable by KBW. 12. Definitive Agreement. This letter reflects KBW's present intention of proceeding to work with CSBC on its proposed conversion. It does not create a binding obligation on the part of Mr. Kim S. Price May 23, 2002 Page 5 of 5 CSBC, the Company or KBW except as to the agreement to maintain the confidentiality of non-public information set forth in Section 3, the payment of certain fees as set forth in Section 7(a) and 7(b) and the assumption of expenses as set forth in Section 9, all of which shall constitute the binding obligations of the parties hereto and which shall survive the termination of this Agreement or the completion of the services furnished hereunder and shall remain operative and in full force and effect. You further Mr. Kim S. Price May 23, 2002 Page 5 of 5 acknowledge that any report or analysis rendered by KBW pursuant to this engagement is rendered for use solely by the management of CSBC and its agents in connection with the Conversion. Accordingly, you agree that you will not provide any such information to any other person without our prior written consent. KBW acknowledges that in offering the Company's stock no person will be authorized to give any information or to make any representation not contained in the offering prospectus and related offering materials filed as part of a registration statement to be declared effective in connection with the offering. Accordingly, KBW agrees that in connection with the offering it will not give any unauthorized information or make any unauthorized representation. We will be pleased to elaborate on any of the matters discussed in this letter at your convenience. If the foregoing correctly sets forth our mutual understanding, please so indicate by signing and returning the original copy of this letter to the undersigned. Sincerely, /s/ Harold T. Hanley, III - ------------------------- Harold T. Hanley, III Managing Director ACCEPTED AND AGREED TO THIS 23RD DAY OF MAY, 2002. Citizens South Banking Corporation By: /s/ Kim S. Price ------------------ Kim S. Price President and CEO EXHIBIT A CONVERSION SERVICES PROPOSAL TO CITIZENS SOUTH BANKING CORPORATION KBW provides thrift institutions converting from mutual to stock form of ownership with a comprehensive program of conversion services designed to promote an orderly, efficient, cost-effective and long-term stock distribution. The following list is representative of the conversion services, if appropriate, we propose to perform on behalf of CSBC. General Services Assist management and legal counsel with the design of the transaction structure. Analyze and make recommendations on bids from printing, transfer agent, and appraisal firms. Assist officers and directors in obtaining Bank loans to purchase stock, if requested. Assist in drafting and distribution of press releases as required or appropriate. Conversion Offering Enhancement Services Establish and manage Stock Information Center at CSBC. Stock Information Center personnel will track prospective investors; record stock orders; mail order confirmations; provide CSBC's senior management with daily reports; answer customer inquiries; and handle special situations as they arise. Assign KBW's personnel to be at CSBC through completion of the Subscription and Community Offerings to manage the Stock Information Center, meet with prospective shareholders at individual and community information meetings, solicit local investor interest through a tele-marketing campaign, answer inquiries, and otherwise assist in the sale of stock in the Subscription and Community Offerings. This effort will be lead by a Principal of KBW. Create target investor list based upon review of CSBC's depositor base. Provide intensive financial and marketing input for drafting of the prospectus. Conversion Offering Enhancement Services - Continued Prepare other marketing materials, including prospecting letters and brochures, and media advertisements. Arrange logistics of community information meeting(s) as required. Prepare audio-visual presentation by senior management for community information meeting(s). Prepare management for question-and-answer period at community information meeting(s). Attend and address community information meeting(s) and be available to answer questions. Broker-Assisted Sales Services Arrange for broker information meeting(s) as required. Prepare audio-visual presentation for broker information meeting(s). Prepare script for presentation by senior management at broker information meeting(s). Prepare management for question-and-answer period at broker information meeting(s). Attend and address broker information meeting(s) and be available to answer questions. Produce confidential broker memorandum to assist participating brokers in selling CSBC's common stock. EX-1.2 4 dex12.txt EXHIBIT 1.2 EXHIBIT 1.2 Exhibit 1.2 CITIZENS SOUTH BANKING CORPORATION (a Delaware-chartered Stock Corporation) Up to 4,600,000 Shares (Subject to Increase Up to 5,290,000 Shares) COMMON STOCK ($.01 Par Value) Subscription Price $10.00 Per Share AGENCY AGREEMENT ___________, 2002 Keefe, Bruyette & Woods 211 Bradenton Drive Dublin, Ohio 43017-5034 Ladies and Gentlemen: Citizens South Banking Corporation, a federally chartered stock corporation (together with its subsidiaries, the "Mid-Tier Holding Company"), Citizens South Banking Corporation, a newly formed Delaware-chartered stock form corporation organized to be the successor of the Mid-Tier Holding Company (the "Holding Company"), Citizens South Holdings, MHC, a federally chartered mutual holding company which owned 58.4% of the common stock of the Mid-Tier Holding Company at December 31, 2001 (the "MHC"), and Citizens South Bank, a federally chartered savings association (together with its subsidiaries, the "Bank") whose common stock is owned in its entirety by the Mid-Tier Holding Company (collectively, the "Citizens Parties") hereby confirm, jointly and severally, their agreement with Keefe, Bruyette & Woods, Inc. ("KBW" or the "Agent"), as follows: Section 1. The Offering. The MHC, in accordance with the Plan of ------------ Conversion and Reorganization adopted May 23, 2002 (the "Plan"), intends to convert from mutual to stock form (the "Conversion"). The Conversion is being conducted in accordance with the laws of the United States and the applicable regulations of the Office of Thrift Supervision ("OTS") (such laws and the regulations of the OTS are referred to herein as the "Conversion Regulations"). In connection with the Conversion, the Holding Company will offer stock on a priority basis to (i) Eligible Account Holders; (ii) Employee Plans of the Holding Company; (iii) Supplemental Eligible Account Holders; and (iv) Other Members (all capitalized terms used in this Agreement and not defined in this Agreement shall have the meanings set forth in the Plan). Pursuant to the Plan, the Holding Company is offering a minimum of 3,400,000 and a maximum of 4,600,000 shares (subject to an increase up to 5,290,000 shares) of common stock, par value $.01 per share (the "Common Stock"), in the Subscription Offering, and, if necessary, (i) the Community Offering and/or (ii) a Syndicated Community Offering. Pursuant to the Plan, the Holding Company will offer and sell shares of its Common Stock (the "Shares") in the Subscription Offering, Community Offering, and/or Syndicated Community Offering (the "Offerings") and issue shares of the Holding Company to existing public shareholders of the Mid-Tier Holding Company in exchange for their existing shares of the Mid-Tier Holding Company (the "Exchange") so that, upon completion of the Offerings, 100% of the outstanding Common Stock of the Holding Company will be publicly held. The Holding Company will sell the Shares in the Offerings at $10.00 per share (the "Purchase Price"). If the number of Shares is increased or decreased in accordance with the Plan, the term "Shares" shall mean such greater or lesser number, where applicable. Pursuant to the Plan, in the Subscription Offering, the Holding Company will offer the Shares, subject to the allocation procedures and purchase limitations set forth in the Plan, in descending order of priority to: (1) Eligible Account Holders; (2) Employee Plans of the Holding Company or the Bank; (3) Supplemental Eligible Account Holders; and (4) Other Members. The Holding Company may offer Shares, if any, remaining after the Subscription Offering, in the Community Offering on a priority basis to the Mid-Tier Holding Company's public stockholders at the Voting Record Date, and then to the natural persons residing within the North Carolina counties of Gaston, Rowan, Iredell, Mecklenburg, Cabarrus, Cleveland, and Lincoln and the South Carolina County of York, and then to the general public. In the event a Community Offering is held, it may be held at any time during or immediately after the Subscription Offering. Depending on market conditions, Shares available for sale but not subscribed for in the Subscription Offering or purchased in the Community Offering may be offered in the Syndicated Community Offering to the general public on a best efforts basis, as described in subsection 4(c) below. The Holding Company has filed with the U.S. Securities and Exchange Commission (the "Commission") Registration Statement on Form S-1 (File No. ___________) in order to register the Shares under the Securities Act of 1933, as amended (the "1933 Act"), and has filed such amendments thereto as have been required to the date hereof (the "Registration Statement"). The prospectus, as amended, included in the Registration Statement at the time it initially became effective is hereinafter called the "Prospectus," except that if any prospectus is filed by the Holding Company pursuant to Rule 424(b) or (c) of the regulations of the Commission under the 1933 Act differing from the prospectus included in the Registration Statement at the time it initially becomes effective, the term "Prospectus" shall refer to the prospectus filed pursuant to Rule 424(b) or (c) from and after the time said prospectus is filed with the Commission and shall include any supplements and amendments thereto from and after their dates of effectiveness or use, respectively. In connection with the Conversion, the MHC filed with the OTS an application for conversion to a stock company (the "Conversion Application") and amendments thereto as required by the OTS. The Holding Company has also filed with the OTS its application on Form H-(e)1-S (the "Holding Company Application") to become a unitary savings and loan holding company under the Home Owners' Loan Act of 1933, as amended, and the regulations promulgated thereunder (the "HOLA"). Collectively, the Conversion Application and the Holding Company Application may also be termed the "Applications." 2 Section 2. Retention of Agent. Subject to the terms and conditions ------------------ herein set forth, the Citizens Parties hereby appoint the Agent as their financial advisor and marketing agent to utilize its best efforts to solicit subscriptions for Shares and to advise and assist the Citizens Parties with respect to the Holding Company's sale of the Shares in the Offering. On the basis of the representations, warranties, and agreements herein contained, but subject to the terms and conditions herein set forth, the Agent accepts such appointment and agrees to consult with and advise the Citizens Parties as to the matters set forth in the letter agreement, dated May 23, 2002, between the Bank and KBW. It is acknowledged by the Citizens Parties that the Agent shall not be required to purchase any Shares or be obligated to take any action that is inconsistent with all applicable laws, regulations, decisions or orders. The obligations of the Agent pursuant to this Agreement shall terminate upon the completion or termination or abandonment of the Plan by the Holding Company or upon termination of the Offering, but in no event later than 90 days after the completion of the Subscription Offering (the "End Date"). All fees or expenses due to the Agent but unpaid will be payable to the Agent in next day funds at the earlier of the Closing Date (as hereinafter defined) or the End Date. In the event the Offering is extended beyond the End Date, the Citizens Parties and the Agent may agree to renew this Agreement under mutually acceptable terms and subject to the approval of any governmental agency or regulatory authority having jurisdiction over such matters. In the event the Holding Company is unable to sell a minimum of 3,400,000 Shares by the End Date, this Agreement shall terminate and the Holding Company shall refund to any persons who have subscribed for any of the Shares the full amount that it may have received from them plus accrued interest, as set forth in the Prospectus, and none of the parties to this Agreement shall have any obligation to the other parties hereunder, except as set forth in this Section 2 and in Sections 9, 11 and 12 hereof. In the event the Offering is terminated for any reason not attributable to the action or inaction of the Agent, the Agent shall be paid the fees due to the date of such termination pursuant to Section 4, subparagraphs (a) and (d), below. Section 3. Sale and Delivery of Shares. If all conditions precedent --------------------------- to the consummation of the Conversion, including, without limitation, the sale of all Shares required by the Plan to be sold, are satisfied, the Holding Company agrees to issue, or have issued, the Shares sold in the Offering and to release for delivery certificates for such Shares on the Closing Date (as hereinafter defined) against payment to the Holding Company by any means authorized by the Plan; provided, however, that no funds shall be released to the Holding Company until the conditions specified in Section 10 hereof shall have been complied with to the reasonable satisfaction of the Agent and its counsel. The release of Shares against payment therefor shall be made on a date and at a place acceptable to the Citizens Parties and the Agent. Certificates for shares shall be delivered directly to the purchasers in accordance with their directions. The date upon which the Holding Company shall release or deliver the Shares sold in the Offering, in accordance with the terms herein, is called the "Closing Date." 3 Section 4. Compensation. The Agent shall receive the following ------------- compensation for its services hereunder: (a) A management fee of $50,000, payable in four consecutive monthly installments of $12,500, commencing with the adoption of the plan of Conversion, of which $12,500 has been paid. Such fees shall be deemed to have been earned when due. Should the Conversion be terminated for any reason not attributable to the action or inaction of the Agent, the Agent shall have earned and be entitled to be paid fees accruing through the stage at which the termination occurred. (b) A Success Fee of 1.35% shall be charged based on the aggregate purchase price of the Shares sold in the Subscription Offering and the Community Offering excluding shares purchased by the officers, directors, corporators, or employees (or members of their immediate families) of the Bank plus any ESOP, tax-qualified or stock based compensation plans (except IRAs) or similar plan created by the Bank for some or all of its directors or employees. The management fee described in subparagraph 4(a) shall be applied against the Success Fee described in this subparagraph 4(b). (c) If any of the Shares remain available after the Subscription Offering, at the request of the Bank, KBW will seek to form a syndicate of registered broker-dealers ("Selected Dealers") to assist in the sale of such Shares on a best efforts basis, subject to the terms and conditions set forth in the selected dealers agreement. KBW will endeavor to distribute the Shares among the Selected Dealers in a fashion which best meets the distribution objectives of the Bank and the Plan. KBW will be paid a fee not to exceed 5.5% of the aggregate purchase price of the shares sold by the Selected Dealers. From this fee, KBW will pass on to the Selected Dealers who assist in such offering an amount competitive with gross underwriting discounts charged at such time for comparable amounts of stock sold at a comparable price per share in a similar market environment. Fees with respect to purchases affected with the assistance of Selected Dealers other than KBW shall be transmitted by KBW to such Selected Dealers. The decision to utilize Selected Dealers will be made by the Bank upon consultation with KBW. In the event, with respect to any stock purchases, fees are paid pursuant to this subparagraph 4(c), such fees shall be in lieu of, and not in addition to, payment pursuant to subparagraph 4(b). (d) The Agent shall be reimbursed for reasonable out-of-pocket expenses, including costs of travel, meals and lodging, photocopying, telephone, facsimile and couriers. The selection of KBW's counsel will be done by KBW, with the approval of the Bank. Reimbursement of KBW's reasonable out-of-pocket expenses, including fees of counsel, shall not exceed $50,000 without the prior consent of the Bank. The Bank will bear the expenses of the Offering customarily borne by issuers including, without limitation, regulatory filing fees, Commission, "Blue Sky," and NASD filing and registration fees; the fees of the Bank's accountants, attorneys, appraiser, transfer agent and registrar, printing, mailing and marketing and syndicate expenses associated with the Conversion; and the fees set forth under this Section 4. The Citizens Parties will reimburse KBW for such expenses incurred by KBW on their behalf. 4 Full payment of KBW's fees and expenses, as described above, shall be made in next day funds on the earlier of the Closing Date or a determination by the Bank to terminate or abandon the Plan. Section 5. Closing. The closing for the sale of the Shares shall take ------- place on the Closing Date at such location as mutually agreed upon by the Agent and the Citizens Parties. At the closing, the Citizens Parties shall deliver to the Agent in next day funds the commissions, fees and expenses due and owing to the Agent as set forth in Sections 4 and 9 hereof and the opinions and certificates required hereby and other documents deemed reasonably necessary by the Agent shall be executed and delivered to effect the sale of the Shares as contemplated hereby and pursuant to the terms of the Prospectus. Section 6. Representations and Warranties of the Citizens Parties. ------------------------------------------------------ The Citizens Parties jointly and severally represent and warrant to the Agent that: (a) Each of the Citizens Parties has all such power, authority, authorizations, approvals and orders as may be required to enter into this Agreement, and, as of the Closing Date, each of the Citizens Parties will have all such power, authority, authorizations, approvals and orders as may be required to carry out the provisions and conditions hereof and to issue and sell the Shares as provided herein and as described in the Prospectus. The consummation of the Conversion, the execution, delivery and performance of this Agreement and the Letter Agreement and the consummation of the transactions contemplated herein have been duly and validly authorized by all necessary corporate action on the part of each of the Citizens Parties. This Agreement has been validly executed and delivered by each of the Citizens Parties, and is a valid, legal and binding obligation of each of the Citizens Parties, in each case enforceable in accordance with its terms, except as the legality, validity, binding nature and enforceability thereof may be limited by (i) bankruptcy, insolvency, moratorium, reorganization, conservatorship, receivership or other similar laws relating to or affecting the enforcement of creditors' rights generally, (ii) general equity principles regardless of whether such enforceability is considered in a proceeding in equity or at law, and (iii) the extent, if any, that the provisions of Sections 11 or 12 hereof may be unenforceable as against public policy. (b) The Registration Statement was declared effective by the Commission on ________, 2002. No stop order has been issued with respect to the Prospectus. No proceedings related to the Prospectus have been initiated or, to the knowledge of the Citizens Parties, threatened by the Commission. At the time the Registration Statement, including the Prospectus contained therein (including any amendment or supplement thereto), became effective, the Registration Statement complied as to form in all material respects with the 1933 Act and the regulations promulgated thereunder. The Registration Statement and the Prospectus did not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. At the time any Rule 424(b) or (c) Prospectus was filed with the Commission and at the Closing Date referred to in Section 5, the Registration Statement, including the Prospectus (including any amendment or supplement thereto) and, when taken together with the Prospectus, any Blue Sky Application or Sales Information authorized for use by any of the Citizens Parties in connection with 5 the Offerings, will not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; provided, however, that the representations and warranties in this Section 6(b) shall not apply to statements or omissions made in reliance upon and in conformity with written information furnished to the Citizens Parties by the Agent expressly regarding the Agent for use under the caption " The Conversion - Plan of Distribution; Selling Agent Compensation." (c) The Conversion Application has been approved by the OTS. The Conversion Application did, and will, as of the Closing Date comply as to form in all material respects with the Conversion Regulations and any other applicable rules and regulations of the OTS. (d) No order has been issued by the Commission preventing or suspending the use of the Registration Statement or the Prospectus and no action by or before any such government entity to revoke any approval, authorization or order of effectiveness related to the Conversion is, to the knowledge of the Citizens Parties, pending or threatened. (e) The Plan has been duly adopted by the Board of the MHC. To the knowledge of the Citizens Parties, no person has, or at the Closing Date will have, sought to obtain review of the final action of the OTS in approving the Conversion Application or the Holding Company Application, pursuant to the Conversion Regulations, the HOLA or any other statute or regulation. (f) The Holding Company has filed the Holding Company Application with the OTS. As of the Closing Date, the OTS will have approved of the Holding Company's becoming a unitary savings and loan holding company with respect to the Bank. (g) RP Financial, LC, which prepared the appraisal of the aggregate pro forma market value of the Common Stock on which the Offerings were based (the "Appraisal"), has advised the Citizens Parties in writing that it is independent with respect to each of the Citizens Parties and the Citizens Parties believe RP Financial, LC to be expert in preparing appraisals of savings institutions. (h) Cherry, Bekaert & Holland, L.L.P., which certified the financial statements filed as part of the Registration Statement and the Conversion Application, has advised the Citizens Parties that it is an independent certified public accountant within the meaning of the Code of Ethics of the AICPA, and Cherry, Bekaert & Holland, L.L.P. is, with respect to the Citizens Parties and each subsidiary thereof, independent certified public accountants as required by the 1933 Act and the regulations promulgated thereunder. (i) The financial statements and the notes thereto which are included in the Registration Statement and which are a part of the Prospectus present fairly in all material respects the consolidated financial condition of the Mid-Tier Holding Company and the Bank as of the dates indicated and the results of operations, changes in stockholders' equity and cash flows for the periods specified. The financial statements comply in all material respects with the applicable accounting requirements of Title 12 of the Code of Federal Regulations, Regulation S-X of the 6 Commission and generally accepted accounting principles ("GAAP") applied on a consistent basis during the periods presented, except as otherwise noted therein, and present fairly in all material respects the information required to be stated therein. The other financial, statistical and pro forma information and related notes included in the Prospectus present fairly the information shown therein on a basis consistent with the audited and any unaudited financial statements included in the Prospectus, and as to the pro forma adjustments, the adjustments made therein have been consistently applied on the basis described therein. (j) Since the respective dates as of which information is given in the Registration Statement, including the Prospectus: (i) there has not been any material adverse change in the financial condition, results of operation, capital, properties, business affairs or prospects of the Citizens Parties considered as one enterprise, whether or not arising in the ordinary course of business; (ii) there have not been any material transactions entered into by any of the Citizens Parties, other than those in the ordinary course of business; and (iii) the capitalization, liabilities, assets, properties and business of the Citizens Parties conform in all material respects to the descriptions thereof contained in the Prospectus and, none of the Citizens Parties has any material liabilities of any kind, contingent or otherwise, except as disclosed in the Registration Statement or the Prospectus. (k) As of the Closing Date, the Holding Company will be a stock corporation duly organized and in good standing under the laws of the State of Delaware, with corporate power and authority to own its properties and to conduct the business currently conducted by the Mid-Tier Holding Company, as described in the Prospectus, and will be qualified to transact business and will be in good standing in Delaware and in each jurisdiction in which the conduct of business requires such qualification, unless the failure to qualify in one or more of such jurisdictions would not have a material adverse effect on the financial condition, results of operation, capital, properties, business affairs or prospects of the Citizens Parties taken as a whole (a "Material Adverse Effect"). As of the Closing Date, the Holding Company will have obtained all licenses, permits and other governmental authorizations required for the conduct of its business, except those that individually or in the aggregate would not have a Material Adverse Effect; and as of the Closing Date, all such licenses, permits and governmental authorizations will be in full force and effect, and the Holding Company will be in compliance therewith in all material respects. (l) As of the date of this Agreement, the Holding Company does not own any equity securities or any equity interest in any business enterprise. (m) The Bank is a duly organized and validly existing federally chartered savings association, duly authorized to conduct its business as described in the Prospectus; the activities of the Bank are permitted by the applicable rules, regulations and practices of the OTS (or valid waivers granted by the OTS from such rules, regulations and practices); the Bank has obtained all licenses, permits and other governmental authorizations currently required for the conduct of its business, except those that individually or in the aggregate would not have a Material Adverse Effect; all such licenses, permits and other governmental authorizations are in full force and effect and the Bank is in good standing under the laws of the United States and the Bank is duly qualified as a foreign 7 corporation to transact business in each jurisdiction in which the failure to so qualify would have a Material Adverse Effect; all of the issued and outstanding capital stock of the Bank after the Conversion will be duly and validly issued and fully paid and nonassessable; and the Holding Company will directly own all of the capital stock of the Bank free and clear of any mortgage, pledge, lien, encumbrance, claim or restriction of any kind. As of the date of this Agreement, the Bank does not own equity securities or any equity interest in any other business enterprise except for (i) marketable equity securities and (ii) other equity interests as described in the Prospectus or as are immaterial in amount and are not required to be described in the Prospectus. (n) The MHC is a federally chartered mutual savings and loan holding company operating under the laws and regulations of the United States and under the supervision of the OTS and is in good standing under such laws. (o) The Mid-Tier Holding Company is a duly organized and validly existing federally chartered mutual savings and loan holding company, duly authorized to conduct its business as described in the Prospectus; the activities of the Mid-Tier Holding Company are permitted by the rules, regulations and practices of the OTS; the Mid-Tier Holding Company has obtained all licenses, permits and other governmental authorizations currently required for the conduct of its business, except those that, individually or in the aggregate, would not have a Material Adverse Effect; all such licenses, permits and other governmental authorizations are in full force and effect and the Mid-Tier Holding Company is in good standing under the laws of United States and the Mid-Tier Holding Company is duly qualified as a foreign corporation to transact business in each jurisdiction in which the failure to so qualify would have a Material Adverse Effect. As of the date of this Agreement, the Mid-Tier Holding Company does not own equity securities or any equity interest in any other business enterprise except for (i) marketable equity securities and (ii) other equity interests as described in the Prospectus or as are immaterial in amount and are not required to be described in the Prospectus. (p) The only active subsidiary of the Bank is Citizens South Financial Services, Inc., doing business as Citizens South Investment Services ("CSIS"). CSIS is organized, validly existing and in good standing under the laws of the State of North Carolina, with full power and authority to own property and conduct its business; CSIS is duly qualified as a foreign corporation to transact business in each jurisdiction in which failure to so qualify would have a material adverse effect on the financial condition, earnings, capital, assets or properties of the Holding Company, the Bank and CSIS taken as a whole; CSIS holds all licenses, certificates and permits from governmental authorities necessary for the conduct of its business, except where failure to hold such licenses, permits or authorizations would not have a material adverse effect on the financial condition, earnings, capital, assets or properties of the Holding Company, the Bank, and CSIS, taken as a whole; the activities of CSIS are permitted to be conducted by subsidiaries of a federally chartered savings institution and of North Carolina corporations. (q) The deposit accounts of the Bank are insured by the FDIC up to applicable limits. Upon consummation of the Conversion, the Bank will establish a liquidation account in accordance with the Plan and the requirements of applicable Conversion Regulations. 8 (r) As of the Closing Date, the Bank will be a wholly owned subsidiary of the Holding Company. (s) Upon consummation of the Conversion, the authorized, issued and outstanding capital stock of the Holding Company will be within the range set forth in the Prospectus under the caption "Capitalization" and no shares of Common Stock have been or will be issued and outstanding prior to the Closing Date (except for the shares issued upon incorporation of the Holding Company); the shares of Common Stock to be subscribed for in the Offerings have been duly and validly authorized for issuance and, when issued and delivered by the Holding Company pursuant to the Plan against payment of the consideration calculated as set forth in the Plan and the Prospectus, will be duly and validly issued and fully paid and nonassessable; the issuance of the Shares is not subject to preemptive rights, except for the subscription rights granted pursuant to the Plan; and the terms and provisions of the shares of Common Stock will conform in all material respects to the description thereof contained in the Prospectus. Upon issuance of the Shares sold, good title to the Shares will be transferred from the Holding Company to the purchasers of Shares against payment therefor in the Offering as set forth in the Plan and the Prospectus. (t) The Citizens Parties are not in violation of their respective certificates of incorporation or charters or their respective bylaws, or in material default in the performance or observance of any obligation, agreement, covenant, or condition contained in any contract, lease, loan agreement, indenture or other instrument to which they are a party or by which they, or any of their respective properties, may be bound which would result in a Material Adverse Effect. The consummation of the transactions contemplated herein and in the Plan will not (i) conflict with or constitute a breach of, or default under, the certificate of incorporation, charter or bylaws of any of the Citizens Parties, or conflict with or constitute a breach of, or default under, any contract, lease or other instrument to which any of the Citizens Parties is a party which breach, default or conflict would have a Material Adverse Effect, or any applicable law, rule, regulation or order that is material to the financial condition of any of the Citizens Parties; (ii) violate any authorization, approval, judgment, decree, order, statute, rule or regulation applicable to the Citizens Parties except for such violations which would not have a Material Adverse Effect; or (iii) result in the creation of any lien, charge or encumbrance upon any property of the Citizens Parties, except for such liens, charges or encumbrances that would not individually or in the aggregate have a Material Adverse Effect. (u) All documents made available to or delivered or to be made available to or delivered by the Citizens Parties or their representatives in connection with the issuance and sale of the Shares, including records of account holders, depositors and borrowers of the Bank, or in connection with the Agent's exercise of due diligence, except for those documents which were prepared by parties other than the Citizens Parties or their representatives, to the best knowledge of the Citizens Parties, were on the dates on which they were delivered, or will be on the dates on which they are to be delivered, true, complete and correct in all material respects. (v) No default exists, and no event has occurred which with notice or lapse of time, or both, would constitute a default on the part of any of the Citizens Parties, in the due performance and observance of any term, covenant or condition of any indenture, mortgage, deed of trust, note, bank 9 loan or credit agreement or any other instrument or agreement to which any of the Citizens Parties is a party or by which any of their property is bound or affected in any respect which, in any such case, would have a Material Adverse Effect on the Citizens Parties taken as a whole, and such agreements are in full force and effect; and no other party to any such agreements has instituted or, to the knowledge of any of the Citizens Parties, threatened any action or proceeding wherein any of the Citizens Parties is alleged to be in default thereunder under circumstances where such action or proceeding, if determined adversely to any of the Citizens Parties, would have a Material Adverse Effect. (w) The Citizens Parties have good and marketable title to all assets which are material to the businesses of the Citizens Parties, free and clear of all liens, charges, encumbrances, restrictions or other claims, except such as are described in the Prospectus or which do not have a Material Adverse Effect; and all of the leases and subleases which are material to the businesses of the Citizens Parties, including those described in the Registration Statement or Prospectus, are in full force and effect. (x) The Citizens Parties are not in violation of any material directive from the OTS, the FDIC, or any other agency to make any material change in the method of conducting their respective businesses; the Citizens Parties have conducted and are conducting their respective businesses so as to comply in all respects with all applicable statutes and regulations (including, without limitation, regulations, decisions, directives and orders of the OTS, the Commission and the FDIC), except where the failure to so comply would not reasonably be expected to result in a Material Adverse Effect, and there is no charge, investigation, action, suit or proceeding before or by any court, regulatory authority or governmental agency or body pending or, to the knowledge of any of the Citizens Parties, threatened, which would reasonably be expected to materially and adversely affect the Conversion, the performance of this Agreement, or the consummation of the transactions contemplated in the Plan as described in the Registration Statement, or which would reasonably be expected to result in a Material Adverse Effect. (y) Prior to the Closing Date, the Citizens Parties will have received an opinion of their special counsel, Luse Gorman Pomerenk & Schick, P.C. with respect to the federal income tax consequences of the Conversion, as described in the Registration Statement and the Prospectus and an opinion of Cherry, Bekaert & Holland, L.L.P. with respect to the state tax consequences of the Conversion, as described in the Registration Statement and the Prospectus; and the facts and representations upon which such opinions will be based, will be truthful, accurate and complete, and none of the Citizens Parties will take any action inconsistent therewith. (z) The Mid-Tier Holding Company and the Bank have filed all required federal and state tax returns, paid all taxes that have become due and payable, except where permitted to be extended or where the failure to pay such taxes would not have a Material Adverse Effect, and no deficiency has been asserted with respect thereto by any taxing authority. (aa) No approval, authorization, consent or other order of any regulatory or supervisory or other public authority is required for the execution and delivery by the Citizens Parties of this 10 Agreement, or the issuance of the Shares, except for the approval of the OTS, the Commission and the Nasdaq Stock Market, Inc., and any necessary qualification, notification, or registration or exemption under the securities or blue sky laws of the various states in which the Shares are to be offered. (bb) None of the Citizens Parties has: (i) issued any securities within the last 18 months (except for (a) notes to evidence bank loans or other liabilities in the ordinary course of business or as described in the Prospectus, and (b) shares of Common Stock issued with respect to the initial capitalization of the Holding Company, and (c) shares of the Mid-Tier Holding Company issued upon the exercise of stock options); (ii) had any dealings with respect to sales of securities within the 12 months prior to the date hereof with any member of the NASD, or any person related to or associated with such member, other than discussions and meetings relating to the Offerings and purchases and sales of U.S. government and agency and other securities in the ordinary course of business; or (iii) engaged any intermediary between the Agent and the Citizens Parties in connection with the Offerings or the offering of shares of the common stock of the Mid-Tier Holding Company, and no person is being compensated in any manner for such services. (cc) The Citizens Parties have not made any payment of funds of the Citizens Parties as a loan to any person for the purchase of Shares, except for the Holding Company's loan to the employee stock ownership plan, the proceeds of which may be used to purchase Shares, or has made any other payment or loan of funds prohibited by law, and no funds have been set aside to be used for any payment prohibited by law. (dd) The Bank complies in all material respects with the applicable financial record keeping and reporting requirements of the Currency and Foreign Transactions Reporting Act of 1970, as amended, and the regulations and rules thereunder. (ee) The Citizens Parties have not relied upon Agent or its counsel for any legal, tax or accounting advice in connection with the Conversion. (ff) The records used by the Citizens Parties to determine the identity of Eligible Account Holders and Supplemental Eligible Account Holders and Other Members are accurate and complete in all material respects. (gg) The Citizens Parties comply with all laws, rules and regulations relating to environmental protection, and none of them has been notified or is otherwise aware that any of them is potentially liable, or is considered potentially liable, under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, or any other Federal, state or local environmental laws and regulations except to the extent that any non-compliance would not have a Material Adverse Effect; no action, suit, regulatory investigation or other proceeding is pending, or to the knowledge of the Citizens Parties, threatened against the Citizens Parties relating to environmental protection, nor do the Citizens Parties have any reason to believe any such proceedings may be brought against any of them; and, to the knowledge of the Citizens Parties, no disposal, release or discharge of hazardous or toxic substances, pollutants or contaminants, including 11 petroleum and gas products, as any of such terms may be defined under federal, state or local law, has occurred on, in, at or about any facilities or properties owned or leased by any of the Citizens Parties or in which the Bank has a security interest, except to the extent such disposal, release or discharge would not have a Material Adverse Effect. (hh) All of the loans represented as assets in the Business of Citizens South Banking Corporation and Citizens South Bank section or financial information of the Citizens Parties included in the Prospectus meet or are exempt from all requirements of federal, state and local law pertaining to lending, including, without limitation, truth in lending (including the requirements of Regulations Z and 12 C.F.R. Part 226), real estate settlement procedures, consumer credit protection, equal credit opportunity and all disclosure laws applicable to such loans, except for violations which, if asserted, would not result in a Material Adverse Effect. (ii) None of the Citizens Parties is required to be registered as an investment company under the Investment Company Act of 1940. (jj) Any certificates signed by an officer of any of the Citizens Parties and delivered to the Agent or its counsel that refer to this Agreement shall be deemed to be a representation and warranty by the Citizens Parties to the Agent as to the matters covered thereby with the same effect as if such representation and warranty were set forth herein. (kk) The Citizens Parties have taken all actions necessary to obtain at Closing a Blue Sky Memorandum from Luse Gorman Pomerenk & Schick. Section 7. Representations and Warranties of the Agent. Agent ------------------------------------------- represents and warrants to the Citizens Parties that: (a) Agent is a duly organized New York corporation and is validly existing and in good standing under the laws of the State of New York with full power and authority to provide the services to be furnished to the Citizens Parties hereunder. (b) The execution, delivery and performance of this Agreement and the Letter Agreement and the consummation of the transactions contemplated herein and therein have been duly and validly authorized by all necessary corporate action on the part of Agent, and each of this Agreement and the Letter Agreement is the legal, valid and binding agreement of Agent, enforceable in accordance with its terms, except as the legality, validity, binding nature and enforceability thereof may be limited by (i) bankruptcy, insolvency, moratorium, reorganization, conservatorship, receivership or other similar laws relating to or affecting the enforcement of creditors' rights generally, and (ii) general equity principles regardless of whether such enforceability is considered in a proceeding in equity or at law. (c) Each of Agent and its employees, agents and representatives who shall perform any of the services hereunder shall have, and until the Offerings are consummated or terminated shall maintain, all licenses, approvals and permits necessary to perform such services and shall comply 12 in all material respects with all applicable laws and regulations in connection with the performance of such services. (d) No action, suit, charge or proceeding before the Commission, the NASD, any state securities commission or any court is pending, or to the knowledge of Agent threatened, against Agent which, if determined adversely to Agent, would have a material adverse effect upon the ability of Agent to perform its obligations under this Agreement. (e) Agent is registered as a broker/dealer pursuant to Section 15(b) of the Securities Exchange Act of 1934, as amended (the "1934 Act") and is a member in good standing of the NASD. (f) Any funds received in the Offerings by the Agent will be handled by the Agent in accordance with Rule 15c2-4 under the 1934 Act to the extent applicable. Section 8. Covenants of the Citizens Parties. The Citizens Parties ---------------------------------- hereby jointly and severally covenant with the Agent as follows: (a) The Holding Company will not, at any time after the date the Registration Statement is declared effective, file any amendment or supplement to the Registration Statement without providing the Agent and its counsel a reasonable opportunity to review and comment on such amendment or supplement. The Holding Company will furnish promptly to the Agent and its counsel copies of all correspondence from the Commission with respect to the Registration Statement and the Holding Company's responses thereto. (b) The Citizens Parties will not, at any time after the date any Application is approved, file any amendment or supplement to such Application without providing the Agent and its counsel a reasonable opportunity to review and comment on such amendment or supplement. The Citizens Parties will furnish promptly to the Agent and its counsel copies of all correspondence from the OTS with respect to the Applications and the Citizens Parties' responses thereto. (c) The Citizens Parties will use their best efforts to cause the OTS to approve the Holding Company's acquisition of the Bank, and will use their best efforts to cause any post-effective amendment to the Registration Statement to be declared effective by the Commission and any post-effective amendment to the Conversion Application to be approved by the OTS, as applicable, and will promptly upon receipt of any information concerning the events listed below notify the Agent (i) when the Registration Statement, as amended, has become effective; (ii) when the Conversion Application as amended, has received the approval of the OTS; (iii) when the Holding Company Application, as amended, has been approved by the OTS; (iv) of the receipt of any comments from the OTS or any other governmental entity with respect to the Conversion or the transactions contemplated by this Agreement; (v) of any request by the Commission, the OTS, or any other governmental entity for any amendment or supplement to the Registration Statement or the Applications or for additional information; (vi) of the issuance by the Commission or the OTS, or any other governmental agency of any order or other action suspending the Offerings or the use 13 of the Registration Statement or the Prospectus or any other filing of the Citizens Parties under the Conversion Regulations or other applicable law, or the threat of any such action; (vii) of the issuance by the Commission or the OTS, or any other state authority of any stop order suspending the effectiveness of the Registration Statement or of the initiation or threat of initiation or threat of any proceedings for that purpose; or (viii) of the occurrence of any event mentioned in subsection (f) below. The Citizens Parties will make every reasonable effort to prevent the issuance by the Commission, the OTS, or any other state authority of any order referred to in (vi) and (vii) above and, if any such order shall at any time be issued, to obtain the lifting thereof at the earliest possible time. (d) The Citizens Parties will deliver to the Agent and to its counsel conformed copies of each of the following documents, with all exhibits: the Applications as originally filed and of each amendment or supplement thereto, and the Registration Statement, as originally filed and each amendment thereto. Further, the Citizens Parties will deliver such additional copies of the foregoing documents to counsel to the Agent as may be required for any NASD filings. In addition, the Citizens Parties will also deliver to the Agent such number of copies of the Prospectus, as amended or supplemented, as the Agent may reasonably request. (e) The Citizens Parties will comply in all material respects with any and all terms, conditions, requirements and provisions with respect to the Conversion and the transactions contemplated thereby imposed by the Commission, by applicable state law and regulations, and by the 1933 Act, the 1934 Act, and the rules and regulations of the Commission promulgated under such Acts, to be complied with prior to the Closing Date; and when the Prospectus is required to be delivered, the Citizens Parties will comply in all material respects, at their own expense, with all requirements imposed upon them by the OTS, the Conversion Regulations (except as modified or waived in writing by the OTS), the Commission, by applicable state law and regulations and by the 1933 Act, the 1934 Act and the rules and regulations of the Commission promulgated under such statutes, in each case as from time to time in force, so far as is necessary to permit the continuance of sales or dealing in shares of Common Stock during such period in accordance with the provisions hereof and the Prospectus. (f) During any period when the Prospectus is required to be delivered, each of the Citizens Parties will inform the Agent of any event or circumstance of which it is or becomes aware as a result of which the Registration Statement and/or Prospectus, as then supplemented or amended, would include an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein not misleading. If it is necessary, in the reasonable opinion of counsel for the Citizens Parties, to amend or supplement the Registration Statement or the Prospectus in order to correct such untrue statement of a material fact or to make the statements therein not misleading in light of the circumstances existing at the time of their use, the Citizens Parties will, at their expense, prepare, file with the Commission and the OTS, and furnish to the Agent, a reasonable number of copies of an amendment or amendments of, or a supplement or supplements to, the Registration Statement and the Prospectus (after a reasonable time for review by counsel for the Agent) which will amend or supplement the Registration Statement and/or the Prospectus so that as amended or supplemented it will not contain an untrue statement of a material 14 fact or omit to state a material fact necessary in order to make the statements therein, in light of the circumstances existing at the time, not misleading. For the purpose of this subsection, each of the Citizens Parties will furnish such information with respect to itself as the Agent may from time to time reasonably request. (g) Pursuant to the terms of the Plan, the Holding Company will endeavor in good faith, in cooperation with the Agent, to register or to qualify the Shares for offering and sale or to exempt such Shares from registration and to exempt the Holding Company and its officers, directors and employees from registration as broker-dealers, under the applicable securities laws of the jurisdictions in which the Offerings will be conducted; provided, however, that the Holding Company shall not be obligated to file any general consent to service of process or to qualify as a foreign corporation to do business in any jurisdiction in which it is not so qualified. In each jurisdiction where any of the Shares shall have been registered or qualified as above provided, the Holding Company will make and file such statements and reports as are required by the applicable regulatory authority in connection with such registration or qualification for a period of not less than one year from the effective date of the Registration Statement. (h) The Holding Company will not sell or issue, contract to sell or otherwise dispose of, for a period of 90 days after the date hereof, any shares of Common Stock or securities convertible into or exercisable for shares of Common Stock, without the Agent's prior written consent other than in connection with any plan or arrangement described in the Prospectus, provided, however, that the Mid-Tier Holding Company shall not be prohibited from issuing shares of Common Stock pursuant to the exercise of previously granted stock options. (i) For a period of three years from the date of this Agreement, the Holding Company will furnish to the Agent, as soon as practical after such information is available (i) a copy of each report of the Holding Company furnished to or filed with the Commission under the 1934 Act or any national securities exchange or system on which any class of securities of the Holding Company is listed or quoted, (ii) a copy of each report of the Holding Company mailed to holders of Common Stock, (iii) each press release and material news item and article released by the Holding Company and/or Bank, and (iv) from time-to-time, such other publicly available information concerning the Citizens Parties as the Agent may reasonably request. (j) The Citizens Parties will use the net proceeds from the sale of the Common Stock in the manner set forth in the Prospectus under the caption "Use of Proceeds." (k) The Holding Company and the Bank will distribute the Prospectus or other offering materials in connection with the offering and sale of the Common Stock only in accordance with the Conversion Regulations of the OTS, the 1933 Act and the 1934 Act and the rules and regulations promulgated under such statutes, and the laws of any state in which the shares are qualified for sale. (l) Prior to the Closing Date, the Holding Company shall register its Common Stock under Section 12(b) or 12(g) of the 1934 Act, and will request that such registration statement shall be effective no later than the completion of the Conversion. 15 (m) For so long as the Shares are registered under the 1934 Act, the Holding Company will furnish to its stockholders as soon as practicable after the end of each fiscal year such reports and other information as are required to be furnished to its stockholders under the 1934 Act. (n) The Holding Company will report the use of proceeds of the Offering in accordance with Rule 463 under the 1933 Act. (o) The Citizens Parties will maintain appropriate arrangements for depositing all funds received from persons mailing subscriptions for or orders to purchase Shares on an interest bearing basis as described in the Prospectus until the Closing Date and satisfaction of all conditions precedent to the release of the Holding Company's obligation to refund payments received from persons subscribing for or ordering Shares in the Offerings, in accordance with the Plan as described in the Prospectus, or until refunds of such funds have been made to the persons entitled thereto or withdrawal authorizations canceled in accordance with the Plan and as described in the Prospectus. The Citizens Parties will maintain such records of all funds received to permit the funds of each subscriber to be separately insured by the FDIC (to the maximum extent allowable) and to enable the Citizens Parties to make the appropriate refunds of such funds in the event that such refunds are required to be made in accordance with the Plan and as described in the Prospectus. (p) The Holding Company will register as a unitary savings and loan holding company under the HOLA. (q) The Citizens Parties will take such actions and furnish such information as are reasonably requested by the Agent in order for the Agent to ensure compliance with the "Interpretation of the Board of Governors of the NASD on Free Riding and Withholding." (r) The Citizens Parties will conduct their businesses in compliance in all material respects with all applicable federal and state laws, rules, regulations, decisions, directives and orders, including all decisions, directives and orders of the Commission, the FDIC and the OTS. (s) The Citizens Parties shall comply with any and all terms, conditions, requirements and provisions with respect to the Conversion and the transactions contemplated thereby imposed by the OTS, the Conversion Regulations, the Commission, the 1933 Act and the regulations promulgated thereunder, the 1934 Act and the regulations promulgated by the Commission pursuant to the 1934 Act to be complied with subsequent to the Closing Date. The Holding Company will comply with all provisions of all undertakings contained in the Registration Statement. (t) The Citizens Parties will not amend the Plan without notifying the Agent prior thereto. (u) The Holding Company shall provide the Agent with any information necessary to allow the Agent to manage the allocation process in order to permit the Holding Company to carry out the allocation of the Shares in the event of an oversubscription, and such information shall be accurate and reliable in all material respects. 16 (v) The Holding Company will not deliver the Shares until the Citizens Parties have satisfied or caused to be satisfied each condition set forth in Section 10 hereof, unless such condition is waived in writing by the Agent. (w) Immediately upon the Closing, (i) all of the issued and outstanding shares of capital stock of the Bank shall be owned by the Holding Company, (ii) the Holding Company shall have no direct subsidiaries other than the Bank, and (iii) the Conversion shall have been effected in accordance with all applicable statutes, regulations, decisions and orders; and all terms, conditions, requirements and provisions with respect to the Conversion (except those that are conditions subsequent) imposed by the Commission, the OTS or any other governmental agency, if any, shall have been complied with by the Citizens Parties in all material respects or appropriate waivers shall have been obtained and all notice and waiting periods shall have been satisfied, waived or elapsed. (x) Prior to the Closing Date, the Plan shall have been approved by the voting members of the MHC and the stockholders of the Mid-Tier Holding Company in accordance with the Plan and the Conversion Regulations and the applicable provisions, if any, of the MHC's charter and bylaws. (y) On or before the Closing Date, the Citizens Parties will have used their best efforts to obtain approval for quotation of shares of the Common Stock on the Nasdaq National Market System by the Closing Date and will use its best efforts to maintain such quotation and will have completed all conditions precedent to the Conversion specified in the Plan and the offer and sale of the Shares will have been conducted in all material respects in accordance with the Plan, the Conversion Regulations (except as modified or waived in writing by the OTS) and with all other applicable laws, regulations, decisions and orders, including all terms, conditions, requirements and provisions precedent to the Conversion imposed upon any of the Citizens Parties by the OTS, the Commission or any other regulatory authority and in the manner described in the Prospectus. (z) The Holding Company shall notify the Agent when funds shall have been received for the minimum number of Shares set forth in the Prospectus. (aa) The officers and directors of the Citizens Parties shall not sell or transfer any shares of common stock of the Mid-Tier Holding Company or Common Stock of the Holding Company commencing on the date hereof and continuing for a period of 90 days following the Closing Date (the "Restricted Period"). The Citizens Parties shall not assist such officers or directors in connection with the sale or transfer of shares of common stock of the Mid-Tier Holding Company or Common Stock of the Holding Company during the Restricted Period. (bb) Other than as permitted by the Conversion Regulations, the HOLA, the 1933 Act, the 1933 Act Regulations and its rules and regulations and the laws of any state in which the Shares are registered or qualified for sale or exempt from registration, none of the Citizens Parties will distribute any prospectus, offering circular or other offering material in connection with the offer and sale of the Shares. 17 (cc) Subsequent to the date the Registration Statement is declared effective by the Commission and prior to the Closing Date, except as otherwise may be indicated or contemplated therein or set forth in an amendment or supplement thereto, none of the Citizens Parties will have: (i) issued any securities or incurred any liability or obligation, direct or contingent, for borrowed money, except borrowings from the same or similar sources indicated in the Prospectus in the ordinary course of its business, or (ii) entered into any transaction which is material in light of the business and properties of the Citizens Parties, taken as a whole. Section 9. Payment of Expenses. Whether or not the Conversion is ------------------- completed or the sale and exchange of the Shares by the Holding Company is consummated, the Citizens Parties will pay for all their expenses incident to the performance of this Agreement, including without limitation: (a) the preparation and filing of the Application and Registration Statement; (b) the preparation, printing, filing, delivery and mailing of the Registration Statement, including the Prospectus, and all documents related to the Offerings and proxy solicitation; (c) all filing fees and expenses in connection with the qualification or registration of the Shares for offer and sale by the Holding Company or the Bank under the securities or "Blue Sky" laws, including without limitation filing fees, reasonable legal fees and disbursements of counsel in connection therewith, and in connection with the preparation of a blue sky law survey; (d) the filing fees of the NASD related to the Agent's fairness filing under NASD Rule 2710 and the application of the Holding Company to list its shares; (e) fees and expenses related to the preparation of the independent appraisal; (f) fees and expenses related to auditing and accounting services; (g) expenses relating to advertising, temporary personnel, investor meetings and stock information center; (h) transfer agent fees and costs of preparation and distribution of stock certificates; and (i) Nasdaq listing fees. The Citizens Parties also agree to reimburse Agent for reasonable out-of-pocket expenses, including legal fees and expenses, incurred by Agent in connection with the services hereunder. Agent will not incur legal fees in excess of $ 35,000 (including counsel's out-of-pocket expenses) without the approval of the Mid-Tier Holding Company. The Agent will not incur other out-of-pocket expenses in excess of $15,000 without prior approval of the Mid-Tier Holding Company. In the event that the Agent incurs any expenses on behalf of the Citizens Parties, the Citizens Parties will pay or reimburse the Agent for such expenses regardless of whether the Conversion is successfully completed, and such reimbursements will not be included in the expense limitations set forth in the following paragraph. The Agent will not incur any single expense of more than $5,000 pursuant to this paragraph without the prior approval of the Mid-Tier Holding Company, MHC or the Bank. The Citizens Parties acknowledge, however, that such limitations may be increased by the mutual consent of the Mid-Tier Holding Company and Agent in the event of delay in the Offering requiring the Agent to utilize a Syndicated Community Offering, a delay as a result of circumstances requiring material additional work by Agent or its counsel or an update of the financial information in tabular form contained in the Prospectus for a period later than March 31, 2002. Not later than two days prior to the Closing Date, the Agent will provide the Bank with a detailed accounting of all reimbursable expenses to be paid at the Closing. Section 10. Conditions to the Agent's Obligations. The obligations of ------------------------------------- the Agent hereunder and the occurrence of the Closing and the Conversion are subject to the condition that all representations and warranties of the Citizens Parties herein contained are, at and as of the 18 commencement of the Offerings and (except to the extent such representations and warranties speak as of an earlier date) at and as of the Closing Date, true and correct, the condition that the Citizens Parties shall have performed, in all material respects, all of their obligations hereunder to be performed on or before such dates and to the following further conditions: (a) The Registration Statement shall have been declared effective by the Commission, the Conversion Application and Holding Company Application shall have been approved by the OTS and no stop order or other action suspending the effectiveness of the Registration Statement shall have been issued under the 1933 Act or proceedings therefor initiated or, to the knowledge of the Citizens Parties, threatened by the Commission or any state authority and no order or other action suspending the authorization for use of the Prospectus or the consummation of the Conversion shall have been issued, or proceedings therefor initiated or, to the knowledge of the Citizens Parties, threatened by the OTS, the Commission, or any other governmental body. (b) At the Closing Date, the Agent shall have received: (1) The opinion, dated as of the Closing Date, of Luse Gorman Pomerenk & Schick, P.C. and/or local counsel acceptable to the Agent, in form and substance satisfactory to the Agent and counsel for the Agent to the effect that: (i) The Holding Company is a corporation duly organized and validly existing and in good standing under the laws of the State of Delaware, with corporate power and authority to own its properties and to conduct the business currently conducted by Mid-Tier Holding Company, as described in the Prospectus, and is duly qualified to transact business and is in good standing in Delaware and in each other jurisdiction in which the conduct of its business requires such qualification, except where the failure to qualify would not have a Material Adverse Effect. (ii) On the date hereof, the Bank is a validly existing federally chartered stock savings association, and upon consummation of the Conversion, the Bank will continue to be a validly existing federally chartered stock savings association, with full power and authority to own its properties and to conduct its business as described in the Prospectus and to enter into this Agreement and perform its obligations hereunder; the activities of the Bank as described in the Prospectus are permitted by federal law and the rules, regulations and practices of the FDIC and the OTS (or valid waivers granted by the OTS from such rules, regulations and practices); the issuance and sale of the capital stock of the Bank to the Holding Company in the Conversion has been duly and validly authorized by all necessary corporate action on the part of the Holding Company and the Bank and, upon payment therefor in accordance with the terms of the Plan, will be validly issued, fully paid and nonassessable and will be owned of record and beneficially by the Holding Company, free and clear of any mortgage, pledge, lien, encumbrance, claim or restriction. Similarly, any subsidiaries of the Bank are validly existing corporations in good standing in the jurisdiction of 19 incorporation and authorized under state and applicable federal law to conduct the businesses in which they now engage. (iii) The activities of the Mid-Tier Holding Company, the MHC and the Bank, as described in the Prospectus, are permitted under applicable federal law (or valid waivers granted by the OTS from such law). To such counsel's knowledge, each of the MHC, the Mid-Tier Holding Company and the Bank has obtained all licenses, permits, and other governmental authorizations that are material for the conduct of its of its business, and all such licenses, permits and other governmental authorizations are in full force and effect, and to such counsel's knowledge the Mid-Tier Holding Company and the Bank comply therewith in all material respects. (iv) The Bank is a member in good standing of the Federal Home Loan Board of Atlanta. The Bank is an insured depository institution under the provisions of the Federal Deposit Insurance Act, as amended, and to such counsel's knowledge, no proceedings for the termination or revocation of the federal deposit insurance of the Bank are pending or threatened. (v) Upon consummation of the Conversion, (a) the authorized, issued and outstanding capital stock of the Holding Company will be within the range set forth in the Prospectus under the caption "Capitalization," and no shares of Common Stock have been or will be issued and outstanding prior to the Closing Date (except for the shares issued upon incorporation of the Holding Company); (b) the shares to be subscribed for in the Offerings will have been duly and validly authorized for issuance, and when issued and delivered by the Holding Company pursuant to the Plan against payment of the consideration calculated as set forth in the Plan, will be duly and validly issued and fully paid and nonassessable; and (c) the issuance of the Shares is not subject to preemptive rights under the certificate of incorporation or bylaws of the Holding Company, or arising or outstanding by operation of law or under any contract, indenture, agreement, instrument or other document known to such counsel, except for the subscription subscription rights under the Plan. To such counsel's knowledge, knowledge, upon issuance of the shares of Common Stock, good title to the shares will be transferred from the Holding Company to the purchasers thereof against payment therefor, subject to such claims as may be asserted against the purchasers thereof by third-party claimants. (vi) The Citizens Parties have full corporate power and authority to enter into this Agreement and to consummate the transactions contemplated hereby and by the Plan. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby have been duly authorized by all necessary corporate action on the part of the Citizens Parties; and this Agreement constitutes a valid, legal and binding obligation of each of the Citizens Parties, enforceable in accordance with its terms, except as rights to indemnity and contribution thereunder may be limited under applicable law, subject to the qualification that (i) enforcement 20 thereof may be limited by bankruptcy, insolvency, moratorium, reorganization or other laws (including the laws of fraudulent conveyance) or judicial decisions affecting the enforceability of creditors' rights generally, the rights of creditors of savings banks or financial institutions, the accounts of which are insured by the FDIC, and (ii) enforcement thereof is subject to general equity principles (regardless of whether such enforceability is considered in a proceeding in equity or at law) and to the effect of certain laws and judicial decisions upon the availability of injunctive relief and enforceability of equitable remedies, including the remedies of specific performance and self-help. (vii) The Plan has been duly adopted by the Board of Directors of the MHC in the manner required by the Conversion Regulations and the MHC's charter and bylaws. The Plan complies in all material respects with the Conversion Regulations. (viii) The Conversion Application and the Holding Company Application have been approved by the OTS, and no action has been taken and, to such counsel's knowledge, none is pending or threatened to revoke such approval or to suspend the offering or the use of the Prospectus, and subject to the satisfaction of any conditions set forth in such approvals, no further approval, registration, authorization, consent or other order of any federal or state regulatory agency, public board or body is required in connection with the execution and delivery of this Agreement, the offer, sale and issuance of the Shares and the consummation of the Conversion, except as may be required under the securities or "Blue Sky" laws of various jurisdictions as to which no opinion need be rendered. (ix) The Registration Statement has become effective under the 1933 Act and to such counsel's knowledge, no stop order suspending the effectiveness of the Registration Statement has been issued, or proceedings for that purpose have been instituted or threatened by the Commission. (x) The terms and provisions of the shares of Common Stock conform to the description thereof contained in the Registration Statement and the Prospectus, and the forms of certificates proposed to be used to evidence the shares of Common Stock are in due and proper form. (xi) At the time the Conversion Application was approved, the Conversion Application (as amended or supplemented), complied as to form in all material respects with the requirements of the Conversion Regulations and all applicable laws, rules and regulations and decisions and orders of the OTS, except as modified or waived in writing by the OTS (other than the financial statements, notes to financial statements, financial tables and other financial and statistical data included therein and the appraisal valuation and the business plan as to which counsel need express 21 no opinion). To such counsel's knowledge, no person has sought to obtain regulatory or judicial review of the final action of the OTS in approving the Applications. (xii) At the time that the Registration Statement became effective and as of the Closing Date, the Registration Statement, including the Prospectus (as amended or supplemented) (other than the financial statements, notes to financial statements, financial tables or other financial and statistical data included therein and the appraisal valuation and the business plan as to which counsel need express no opinion), complied as to form in all material respects with the requirements of the 1933 Act and the rules and regulations promulgated thereunder. (xiii) To such counsel's knowledge, there are no legal or governmental proceedings pending, or threatened (i) asserting the invalidity of this Agreement, (ii) seeking to prevent the Conversion or the offer, sale or issuance of the Shares, or (iii) which are required to be disclosed in the Registration Statement and Prospectus, other than those disclosed therein. (xiv) The information in the Prospectus under the captions "Supervision and Regulation," "Taxation," "Restrictions on Acquisition of Citizens South Banking Corporation," "Description of Capital Stock of Citizens South Banking Corporation," and "The Conversion," to the extent that such information constitutes matters of law, summaries of legal matters, documents or proceedings, or legal conclusions, has been reviewed by such counsel and is accurate in all material respects. (xv) None of the Citizens Parties are required to be registered as an investment company under the Investment Company Act of 1940. (xvi) None of the Citizens Parties is in violation of its Certificate of Incorporation or its charter, as the case may be, or its bylaws or, to such counsel's knowledge, any obligation, agreement, covenant or condition contained in any contract, indenture, mortgage, loan agreement, note, lease or other instrument filed as an exhibit to, or incorporated by reference in, the Registration Statement, which violation would have a Material Adverse Effect. In addition, the execution and delivery of and performance under this Agreement by the Citizens Parties, the incurrence of the obligations set forth herein and the consummation of the transactions contemplated herein will not result in (i) any violation of the provisions of the articles of incorporation or charter, as the case may be, or the bylaws of any of the Citizens Parties, (ii) any violation of any applicable law, act, regulation, or to such counsel's knowledge, order or court order, writ, injunction or decree, and (iii) any violation of any obligation, agreement, covenant or condition contained in any contract, indenture, mortgage, loan agreement, note, lease or other instrument filed as an exhibit to, or incorporated by reference in, the Registration Statement or otherwise known by such counsel which should have otherwise been filed as an 22 exhibit to the Registration Statement, which violation would have a Material Adverse Effect. (xvii) To such counsel's knowledge, the Citizens Parties have obtained all material licenses, permits and other governmental authorizations currently required for the conduct of their businesses and all such licenses, permits and other governmental authorizations are in full force and effect, and the Citizens Parties are in all material respects complying therewith. (xviii) The Holding Company's Articles of Incorporation and Bylaws comply in all material respects with the laws of the State of Delaware. The Bank's respective Charter and Bylaws comply in all material respects with federal law. (xix) To such counsel's knowledge, none of the Citizens Parties is in violation of any directive from the OTS or the FDIC to make any material change in the method of conducting its respective business. (xx) To such counsel's knowledge, there are no material contracts, indentures, mortgages, loan agreements, notes, leases or other instruments required to be described or referred to in the Conversion Application, the Registration Statement or the Prospectus or required to be filed as exhibits thereto other than those described or referred to therein or filed as exhibits thereto in the Conversion Application, the Registration Statement or the Prospectus. The description in the Conversion Application, the Registration Statement and the Prospectus of such documents and exhibits is accurate in all material respects and fairly presents the information required to be shown. (xxi) CSIS has been duly incorporated and is validly existing as a corporation under the laws of the jurisdiction of its incorporation, has full corporate power and authority to own, lease and operate its properties and to conduct its business as described in the Registration Statement and the Prospectus and is duly qualified as a foreign corporation to transact business in each jurisdiction in which the failure to so qualify would have a material adverse effect upon the financial condition, results of operations or business of the Company, the Bank and CSIS, considered as one enterprise; the activities of CSIS, as described in the Registration Statement and the Prospectus, are permitted to subsidiaries of a Delaware corporation and of a federally-chartered stock savings bank under the rules, regulations, policies and practices of the OTS and all other federal banking or non-federal governmental agencies and regulatory authorities having jurisdiction thereover; to the best of such counsel's knowledge, free and clear of any material security interest, mortgage, pledge, lien, encumbrance, claim or equity. 23 The Agent's counsel may rely for purposes of its own opinion on the opinion of Luse Gorman Pomerenk & Schick, P.C. whose opinion shall expressly authorize such reliance. The opinion may be limited to matters governed by the laws of the United States and the corporate laws of the State of Delaware. In rendering such opinion, such counsel may rely (A) as to matters involving the application of laws of any jurisdiction other than the United States, to the extent such counsel deems proper and specified in such opinion, upon the opinion of counsel reasonably acceptable to the Agent, as long as such other opinion indicates that the Agent may rely on the opinion, and (B) as to matters of fact, to the extent such counsel deems proper, on certificates of responsible officers of the Citizens Parties and public officials; provided copies of any such opinion(s) or certificates of public officials are delivered to Agent together with the opinion to be rendered hereunder by special counsel to the Citizens Parties. In rendering such opinion, all statements contained therein "to our knowledge" or "to our attention" or "known to us" means the knowledge, following reasonable investigation, of the attorneys who have worked on the transactions contemplated herein. The opinion of such counsel for the Citizens Parties shall state that it has no reason to believe that the Agent is not reasonably justified in relying thereon. (2) A letter of Luse Gorman Pomerenk & Schick, P.C. which shall state that during the preparation of the Registration Statement and the Prospectus, Luse Gorman Pomerenk & Schick, P.C. participated in conferences with certain officers of and other representatives of the Citizens Parties, counsel to the Agent, representatives of the independent public accountants for the Citizens Parties and representatives of the Agent at which the contents of the Registration Statement and the Prospectus and related matters were discussed and has considered the matters required to be stated therein and the statements contained therein and, although (without limiting the opinions provided pursuant to Section 10(b)(1)), Luse Gorman Pomerenk & Schick, P.C. has not independently verified the accuracy, completeness or fairness of the statements contained in the Registration Statement and Prospectus, on the basis of the foregoing, nothing has come to the attention of Luse Gorman Pomerenk & Schick, P.C. that caused Luse Gorman Pomerenk & Schick, P.C. to believe that the Registration Statement at the time it was declared effective by the Commission and as of the date of such letter, contained or contains any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein in light of the circumstances under which they were made not misleading (it being understood that counsel need express no comment or opinion with respect to statements, notes to financial statements, schedules and other financial and statistical data included, or statistical or appraisal methodology employed, in the Registration Statement or Prospectus, the appraisal valuation or the business plan). (3) A Blue Sky Memorandum from Luse Gorman Pomerenk & Schick, P.C. relating to the offering, including Agent's participation therein, and should be furnished to Agent with a copy thereof addressed to Agent or upon which Luse Gorman Pomerenk & Schick, P.C. shall state Agent may rely. The Blue Sky Memorandum will relate to the necessity of obtaining or confirming exemptions, qualifications or the registration of the common stock under applicable state securities law. 24 (c) Concurrently with the execution of this Agreement, the Agent shall receive a letter from Cherry, Bekaert & Holland, L.L.P., dated the date hereof and addressed to the Agent, such letter (i) confirming that Cherry, Bekaert & Holland, L.L.P. is a firm of independent public accountants within the meaning of the 1933 Act and the regulations promulgated thereunder, and stating in effect that in Cherry, Bekaert & Holland, L.L.P.'s opinion the consolidated financial statements of the Mid-Tier Holding Company included in the Prospectus comply as to form in all material respects with the applicable accounting requirements of the 1933 Act and the 1934 Act and the related rules and regulations of the Commission thereunder; (ii) stating in effect that, on the basis of certain agreed upon procedures (but not an audit examination in accordance with generally accepted auditing standards) consisting of a review (in accordance with Statement of Auditing Standards No. 71) of the latest available unaudited consolidated interim financial statements of the Mid-Tier Holding Company prepared by the Citizens Parties, a reading of the minutes of the meetings of the Board of Directors, Executive Committee and stockholders and Audit Committee of the Mid-Tier Holding Company and the Bank and consultations with officers of the Mid-Tier Holding Company and the Bank responsible for financial and accounting matters, nothing came to their attention which caused them to believe that: (A) such unaudited consolidated financial statements included in the Prospectus are not in conformity with generally accepted accounting principles applied on a basis substantially consistent with that of the audited financial statements included in the Prospectus; or (B) during the period from the date of the latest unaudited consolidated financial statements included in the Prospectus to a specified date not more than five business days prior to the date of the Prospectus, there was any material increase in borrowings (defined as securities sold under agreements to repurchase and any other form of debt other than deposits), or non-performing loans, special mention loans or decrease in the deposits or loan allowance, total assets, stockholders' equity or there was any change in common stock outstanding (other than for stock option plans) at the date of such letter as compared with amounts shown in the latest unaudited statement of condition or there was any decrease in net income, non-interest income, provision for loan losses or net income after provision or increase in non-interest expense of the Mid-Tier Holding Company for the period commencing immediately after the period covered by the latest unaudited income statement and ended not more than five business days prior to the date of the Prospectus as compared to the corresponding period in the preceding year; and (iii) stating that, in addition to the audit examination referred to in its opinion included in the Prospectus and the performance of the procedures referred to in clause (ii) of this subsection (c), they have compared with the general accounting records of the Mid-Tier Holding Company, which are subject to the internal controls of the accounting system of the Mid-Tier Holding Company and other data prepared by the Citizens Parties from accounting records, to the extent specified in such letter, such amounts and/or percentages set forth in the Prospectus as the Agent may reasonably request, and they have found such amounts and percentages to be in agreement therewith (subject to rounding). (d) At the Closing Date, the Agent shall receive a letter from Cherry, Bekaert & Holland, L.L.P. dated the Closing Date, addressed to the Agent, confirming the statements made by its letter delivered by it pursuant to subsection (c) of this Section 10, the "specified date" referred to in clause (ii)(B) thereof to be a date specified in such letter, which shall not be more than three business days prior to the Closing Date. 25 (e) At the Closing Date, counsel to the Agent shall have been furnished with such documents and opinions as counsel for the Agent may require for the purpose of enabling them to advise the Agent with respect to the issuance and sale of the Common Stock as herein contemplated and related proceedings, or in order to evidence the accuracy of any of the representations and warranties, or the fulfillment of any of the conditions herein contained. (f) At the Closing Date, the Agent shall receive a certificate of the Chief Executive Officer and Chief Financial Officer of each of the Citizens Parties, dated the Closing Date, to the effect that: (i) they have examined the Registration Statement and at the time the Registration Statement became authorized for final use, the Prospectus did not contain an untrue statement of a material fact or omit to state a material fact necessary in order to make the statements therein not misleading; (ii) there has not been, since the respective dates as of which information is given in the Registration Statement, any Material Adverse Effect otherwise than as set forth or contemplated in the Registration Statement; (iii) the representations and warranties contained in Section 6 of this Agreement are true and correct with the same force and effect as though made at and as of the Closing Date; (iv) the Citizens Parties have complied in all material respects with all material agreements and satisfied all conditions on its part to be performed or satisfied at or prior to the Closing Date including the conditions contained in this Section 10; (v) no stop order has been issued or, to their knowledge, is threatened, by the Commission or any other governmental body; (vi) no order suspending the Offering, the Conversion, the acquisition of all of the shares of the Bank by the Holding Company, the transactions required under the Plan to consummate the Conversion or the effectiveness of the Prospectus has been issued and to their knowledge, no proceedings for any such purpose have been initiated or threatened by the OTS, the Commission, or any other federal or state authority; (vii) to their knowledge, no person has sought to obtain regulatory or judicial review of the action of the OTS in approving the Plan or to enjoin the Conversion, and (viii) that the officers and directors of the Citizens Parties have agreed to abide by the restrictions on the sale of Common Stock set forth in Section 8(aa). (g) At the Closing Date, the Agent shall receive a letter from RP Financial, LC, dated as of the Closing Date, (i) confirming that said firm is independent of the Citizens Parties and is experienced and expert in the area of corporate appraisals, (ii) stating in effect that the Appraisal complies in all material respects with the applicable requirements of the Conversion Regulations, and (iii) further stating that its opinion of the aggregate pro forma market value of the Citizens Parties, as converted, expressed in the appraisal as most recently updated, remains in effect. (h) None of the Citizens Parties shall have sustained, since the date of the latest financial statements included in the Registration Statement and Prospectus, any material loss or interference with its business from fire, explosion, flood or other calamity, whether or not covered by insurance, or from any labor dispute or court or governmental action, order or decree, otherwise than as set forth in the Registration Statement and the Prospectus, and since the respective dates as of which information is given in the Registration Statement and the Prospectus, there shall not have been any Material Adverse Effect, is in the Agent's reasonable judgment sufficiently material and adverse as to make it impracticable or inadvisable to proceed with the Offerings or the delivery of the Shares on the terms and in the manner contemplated in the Prospectus. 26 (i) Prior to and at the Closing Date, in the reasonable opinion of the Agent there shall have been no material adverse change in the financial condition or in the earnings, business affairs or prospects of any of the Citizens Parties independently, or the Citizens Parties taken as a whole, from and as of the latest dates as of which such condition is set forth in the Prospectus, except as referred to therein. (j) At or prior to the Closing Date, the Agent shall receive (i) a copy of the Conversion Application and a copy of the letter from the OTS approving the Conversion Application, (ii) a copy of the order from the Commission declaring the Registration Statement effective, (iii) an executed copy of the certificate of incorporation of the Holding Company, (iv) a copy of the letter from the OTS approving the Holding Company Application, (v) a certificate from the FDIC evidencing the Bank's insurance of accounts, and (vi) any other documents that Agent shall reasonably request. (k) Subsequent to the date hereof, there shall not have occurred any of the following: (i) a suspension or limitation in trading in securities generally on the New York Stock Exchange or American Stock Exchange or in the over-the-counter market, or quotations halted generally on the Nasdaq Stock Market, or minimum or maximum prices for trading have been fixed, or maximum ranges for prices for securities have been required by either of such exchanges or the NASD or by order of the Commission or any other governmental authority other than temporary trading halts or limitation (A) imposed as a result of intraday changes in the Dow Jones Industrial Average, (B) lasting no longer than until the regularly scheduled commencement of trading on the next succeeding business-day and (C) which when combined with all other such halts occurring during the previous five (5) business days, total less than two (2); (ii) a general moratorium on the operations of federally-insured financial institutions or a general moratorium on the withdrawal of deposits from commercial banks or other federally-insured financial institutions declared by either federal or state authorities; or (iii) there shall not have occurred any material adverse change in the financial markets in the United States or elsewhere or any outbreak of hostilities or escalation thereof or other calamity or crisis, including, without limitation, terrorist activities after the date hereof, the effect of which, in the judgment of the Agent, is so material and adverse as to make it impracticable to market the Shares or to enforce contracts, including subscriptions or purchase orders, for the sale of the Shares. (l) All such opinions, certificates, letters and documents will be in compliance with the provisions hereof only if they are reasonably satisfactory in form and substance to the Agent and to counsel for the Agent. Any certificate signed by an officer of the Mid-Tier Holding Company, the Holding Company or the Bank and delivered to the Agent or to counsel for the Agent shall be deemed a representation and warranty by the Mid-Tier Holding Company, the Holding Company or the Bank, as the case may be, to the Agent as to the statements made therein. Section 11. Indemnification. --------------- (a) The Citizens Parties jointly and severally agree to indemnify and hold harmless the Agent, its officers, directors, agents, attorneys, servants and employees and each person, if any, who controls the Agent within the meaning of Section 15 of the 1933 Act or Section 20(a) of the 1934 Act, against any and all loss, liability, claim, damage or expense whatsoever (including but not 27 limited to settlement expenses, subject to the limitation set forth in the last sentence of subsection (c) below), joint or several, that the Agent or any of such officers, directors, agents, attorneys, servants, employees and controlling Persons (collectively, the "Related Persons") may suffer or to which the Agent or the Related Persons may become subject under all applicable federal and state laws or otherwise, and to promptly reimburse the Agent and any Related Persons upon written demand for any reasonable expenses (including reasonable fees and disbursements of counsel and Agent's time spent according to normal hourly rates) incurred by the Agent or any Related Persons in connection with investigating, preparing or defending any actions, proceedings or claims (whether commenced or threatened) to the extent such losses, claims, damages, liabilities or actions: (i) arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement (or any amendment or supplement thereto), the Prospectus (or any amendment or supplement thereto), the Applications, or other instrument or document of the Citizens Parties or based upon written information supplied by any of the Citizens Parties filed in any state or jurisdiction to register or qualify any or all of the Shares under the securities laws thereof (collectively, the "Blue Sky Applications"), or any application or other document, advertisement, or communication ("Sales Information") prepared, made or executed by or on behalf of any of the Citizens Parties with its consent or based upon information furnished by or on behalf of any of the Citizens Parties, in order to qualify or register the Shares under the securities laws thereof, (ii) arise out of or are based upon the omission or alleged omission to state in any of the foregoing documents or information, a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; (iii) arise from any theory of liability whatsoever relating to or arising from or based upon the Registration Statement (or any amendment or supplement thereto), the Prospectus (or any amendment or supplement thereto), the Applications, any Blue Sky Applications or Sales Information or other documentation distributed in connection with the Offerings; or (iv) result from any claims made with respect to the accuracy, reliability and completeness of the records identifying the Eligible Account Holders and Supplemental Eligible Account Holders or Other Members or for any denial or reduction of a subscription or order to purchase Common Stock, whether as a result of a properly calculated allocation pursuant to the Plan or otherwise, based upon such records; provided, however, that no indemnification is required under this subsection (a) to the extent such losses, claims, damages, liabilities or actions arise out of or are based upon any untrue material statements or alleged untrue material statements in, or material omission or alleged material omission from, the Registration Statement (or any amendment or supplement thereto) or the Prospectus (or any amendment or supplement thereto), the Applications, the Blue Sky Applications or Sales Information or other documentation distributed in connection with the Conversion made in reliance upon and in conformity with information furnished to the Citizens Parties by the Agent or its representatives (including counsel) with respect to the Agent expressly for use in the Registration Statement (or any amendment or supplement thereto) or Prospectus (or any amendment or supplement thereto) under the caption "The Conversion -- Plan of Distribution; Selling Agent Compensation" except for information derived from the Prospectus. Provided further, that the Citizens Parties will not be responsible for any loss, liability, claim, damage or expense to the extent a court of competent jurisdiction finds they result primarily from material oral misstatements by the Agent to a purchaser or prospective purchaser of Shares which are not based upon information in the Registration Statement or Prospectus, or from actions taken or omitted to be taken by the Agent in bad faith or 28 from the Agent's gross negligence or willful misconduct and the Agent agrees to repay to the Citizens Parties any amounts advanced to it by the Citizens Parties in connection with matters as to which it is found by a court of competent jurisdiction not to be entitled to indemnification hereunder. (b) The Agent agrees to indemnify and hold harmless the Citizens Parties, their directors and officers, agents, attorneys, servants and employees and each person, if any, who controls any of the Citizens Parties within the meaning of Section 15 of the 1933 Act or Section 20(a) of the 1934 Act against any and all loss, liability, claim, damage or expense whatsoever (including but not limited to settlement expenses, subject to the limitation set forth in the last sentence of subsection (c) below), joint or several, which they, or any of them, may suffer or to which they, or any of them, may become subject under all applicable federal and state laws or otherwise, and to promptly reimburse the Citizens Parties and any such persons upon written demand for any reasonable expenses (including out-of-pocket expenses, fees and disbursements of counsel) incurred by them in connection with investigating, preparing or defending any actions, proceedings or claims (whether commenced or threatened) to the extent such losses, claims, damages, liabilities or actions arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement (or any amendment or supplement thereto), the Applications or any Blue Sky Applications or Sales Information or are based upon the omission or alleged omission to state in any of the foregoing documents a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; provided, however, that the Agent's obligations under this Section 11(b) shall exist only if and only to the extent that such untrue statement or alleged untrue statement was made in, or such material fact or alleged material fact was omitted from, the Applications, Registration Statement (or any amendment or supplement thereto) or the Prospectus (or any amendment or supplement thereto) in reliance upon and in conformity with information furnished to the Citizens Parties by the Agent or its representatives (including counsel) expressly for use under the caption "The Conversion - Plan of Distribution; Selling Agent Compensation." (c) Each indemnified party shall give prompt written notice to each indemnifying party of any action, proceeding, claim (whether commenced or threatened), or suit instituted against it in respect of which indemnity may be sought hereunder, but failure to so notify an indemnifying party shall not relieve it from any liability which it may have on account of this Section 11, Section 12 or otherwise, unless the failure to give such notice promptly results in material prejudice to the indemnifying party. An indemnifying party may participate at its own expense in the defense of such action. In addition, if it so elects within a reasonable time after receipt of such notice, an indemnifying party, jointly with any other indemnifying parties receiving such notice, may assume the defense of such action with counsel chosen by it reasonably acceptable to the indemnified parties that are defendants in such action, unless such indemnified parties reasonably object to such assumption on the ground that there may be legal defenses available to them that are different from or in addition to those available to such indemnifying party. If an indemnifying party assumes the defense of such action, the indemnifying parties shall not be liable for any fees and expenses of counsel for the indemnified parties incurred thereafter in connection with such action, proceeding or claim, other than reasonable costs of investigation. In no event shall the indemnifying parties be liable for the fees and expenses of more than one separate firm of attorneys (unless an indemnified 29 party or parties shall have reasonably concluded that there may be defenses available to it or them which are different from or in addition to those of other indemnified parties) for all indemnified parties in connection with any one action, proceeding or claim or separate but similar or related actions, proceedings or claims in the same jurisdiction arising out of the same general allegations or circumstances. No indemnifying party shall be liable for any settlement of any action, proceeding or suit, which settlement is effected without its prior written consent. Neither the Citizens Parties nor the Agent shall, without the written consent of the other, settle or compromise any claim against them or it based upon circumstances giving rise to an indemnification claim against the other party hereunder unless such settlement or compromise provides that the indemnified party shall be unconditionally and irrevocably released from all liability in respect to such claim. (d) The agreements contained in this Section 11 and in Section 12 hereof and the representations and warranties of the Citizens Parties set forth in this Agreement shall remain operative and in full force and effect regardless of (i) any investigation made by or on behalf of the Agent or its officers, directors, controlling persons, agents, attorneys, servants or employees or by or on behalf of any of the Citizens Parties or any officers, directors, controlling persons, agents, attorneys , servants or employees of any of the Citizens Parties; (ii) delivery of and payment hereunder for the Shares; or (iii) any termination of this Agreement. Notwithstanding the prior sentence, Sections 11 and 12 hereof are subject to and limited by Section 23A of the Federal Reserve Act, as applicable. Section 12. Contribution. ------------ (a) In order to provide for just and equitable contribution in circumstances in which the indemnification provided for in Section 11 is due in accordance with its terms but is found in a final judgment by a court to be unavailable from the Citizens Parties or the Agent, the Citizens Parties and the Agent shall contribute to the aggregate losses, claims, damages and liabilities of the nature contemplated by such indemnification (including any investigation, legal and other expenses incurred in connection therewith and any amount paid in settlement of any action, suit, or proceeding of any claims asserted, but after deducting any contribution received by the Citizens Parties or the Agent from persons other than the other party thereto, who may also be liable for contribution) in such proportion so that (i) the Agent is responsible for that portion represented by the percentage that the fees paid to the Agent pursuant to Section of this Agreement (not including expenses) ("Agent's Fees), less any portion of Agent's Fees paid by Agent to Assisting Brokers, bear to the total proceeds received by the Citizens Parties from the sale of the Shares in the Offering, net of all expenses of the Offering, except Agent's fees and (ii) the Citizens Parties shall be responsible for the balance. If, however, the allocation provided above is not permitted by applicable law or if the indemnified party failed to give the notice required under Section 11 above, then each indemnifying party shall contribute to such amount paid or payable to such indemnified party in such proportion as is appropriate to reflect not only such relative fault of the Citizens Parties on the one hand and the Agent on the other in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities (or actions, proceedings or claims in respect thereof), but also the relative benefits received by the Citizens Parties on the one hand and the Agent on the other from the Offering, as well as any other relevant equitable considerations. The relative benefits received 30 by the Citizens Parties on the one hand and the Agent on the other hand shall be deemed to be in the same proportion as the total proceeds from the Offering, except Agent's fees, net of all expenses of the Offering, received by the Citizens Parties bear, with respect to the Agent, to the total fees (not including expenses) received by the Agent less the portion of such fees paid by the Agent to Assisting Brokers. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Citizens Parties on the one hand or the Agent on the other and the parties relative intent, good faith, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Citizens Parties and the Agent agree that it would not be just and equitable if contribution pursuant to this Section 12 were determined by pro-rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to above in this Section 12. The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities (or action, proceedings or claims in respect thereof) referred to above in this Section 12 shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action, proceeding or claim. It is expressly agreed that the Agent shall not be liable for any loss, liability, claim, damage or expense or be required to contribute any amount which in the aggregate exceeds the amount paid (excluding reimbursable expenses) to the Agent under this Agreement less the portion of such fees paid by the Agent to Assisting Brokers. It is understood and agreed that the above-stated limitation on the Agent's liability is essential to the Agent and that the Agent would not have entered into this Agreement if such limitation had not been agreed to by the parties to this Agreement. No person found guilty of any fraudulent misrepresentation (within the meaning of Section 11(f) of the 1933 Act) shall be entitled to contribution with respect to any loss or liability arising from such misrepresentation from any person who was not found guilty of such fraudulent misrepresentation. The duties, obligations and liabilities of the Citizens Parties and the Agent under this Section 12 and under Section 11 shall be in addition to any duties, obligations and liabilities which the Citizens Parties and the Agent may otherwise have. For purposes of this Section 12, each of the Agent's and the Citizens Parties' officers, directors and, controlling persons within the meaning of the 1933 Act and the 1934 Act shall have the same rights to contribution as the Citizens Parties and the Agent. Any party entitled to contribution, promptly after receipt of notice of commencement of any action, suit, claim or proceeding against such party in respect of which a claim for contribution may be made against another party under this Section 12, will notify such party from whom contribution may be sought, but the omission to so notify such party shall not relieve the party from whom contribution may be sought from any other obligation it may have hereunder or otherwise than under this Section 12. Section 13. Survival. -------- (a) All representations, warranties and indemnities and other statements contained in this Agreement (and in Paragraph 11 of the Letter Agreement), or contained in certificates of officers of the Citizens Parties or the Agent submitted pursuant hereto, shall remain operative and in full force and effect, regardless of any termination or cancellation of this Agreement or any investigation made by or on behalf of the Agent or its controlling persons, or by or on behalf of the Citizens Parties and shall survive the issuance of the Shares, and any legal representative, successor or assign of the 31 Agent, any of the Citizens Parties, and any indemnified person shall be entitled to the benefit of the respective agreements, indemnities, warranties and representations. (b) The provisions of Paragraph 10 of the Letter Agreement, "Availability of `Stars' Program," shall survive the issuance of the Shares (but not any termination or cancellation of this Agreement) for a period of one (1) year, and any legal representative, successor or assign of the Agent, and any of the Citizens Parties shall be entitled during such period to the benefit of the agreements contained therein. Section 14. Termination. Agent may terminate this Agreement by giving ----------- the notice indicated below in this Section at any time after this Agreement becomes effective as follows: (a) In the event (i) the Plan is abandoned or terminated by the Holding Company; (ii) the Holding Company fails to consummate the sale of the minimum number of Shares prior to ___________, 2003 in accordance with the provisions of the Plan or as required by the Conversion Regulations and applicable law; or (iii) immediately prior to commencement of the Offering, the Agent terminates this relationship because in its opinion, which shall have been formed in good faith after reasonable determination and consideration of all relevant factors, there has been a failure to satisfactorily disclose all relevant information in the Prospectus or the existence of market conditions which might render the sale of the Shares inadvisable, this Agreement shall terminate and the Citizens Parties shall refund to each person who has subscribed for or ordered any of the Shares the full amount which it may have received from such person, together with interest in accordance with Section 2 hereof and any such termination shall be without liability of any party to any other party except as otherwise provided in Sections 2, 4, 9, 11 and 12 hereof. (b) If any of the conditions specified in Section 10 hereof shall not have been fulfilled when and as required by this Agreement, or by _____________, 2003, or waived in writing by the Agent, this Agreement and all of the Agent's obligations hereunder may be canceled by the Agent by notifying the Bank of such cancellation in writing at any time at or prior to the Closing Date, and any such cancellation shall be without liability of any party to any other party except as otherwise provided in Sections 2, 4, 9, 11 and 12 hereof. (c) If Agent elects to terminate this Agreement as provided in this Section, the Mid-Tier Holding Company and the MHC shall be notified by the Agent as provided in Section 15 hereof. (d) If this Agreement is terminated in accordance with the provisions of this Agreement, the Agent shall retain the advisory and management fee paid to it pursuant to Section 4 and the Citizens Parties shall reimburse the Agent for any of its other actual, accountable, reasonable out-of-pocket expenses pursuant to Section 9, including without limitation, communication, legal and travel expenses. Section 15. Notices. All notices and other communications hereunder ------- shall be in writing and shall be deemed to have been duly given if mailed or transmitted by any standard form of telecommunication. Notices to Agent shall be directed to Keefe, Bruyette & Woods, Inc., 211 32 Bradenton Drive, Dublin, Ohio 43017, Attention: Mr. Harold Hanley; notices to the Citizens Parties shall be directed to Citizens South Banking Corporation, P.O. Box 2249, Gastonia, North Carolina 28053, Attention: Kim S. Price, President and Chief Executive Officer (with a copy to Luse Gorman Pomerenk & Schick, P.C., 5535 Wisconsin Avenue, N.W., Washington, D.C. 20005, Attention: Robert B. Pomerenk, Esq.) Section 16. Parties. This Agreement shall inure to the benefit of and ------- be binding upon the Agent and the Citizens Parties, and their respective successors. Nothing expressed or mentioned in this Agreement is intended or shall be construed to give any person, firm or corporation, other than the parties hereto and their respective successors and the controlling persons and officers and directors referred to in Sections 11 and 12 and their heirs and legal representatives, any legal or equitable right, remedy or claim under or in respect of this Agreement or any provisions herein contained. It is understood and agreed that this Agreement is the exclusive agreement among the parties, supersedes any prior Agreement among the parties and may not be varied except by a writing signed by all parties, except for Paragraphs 4, 10, 11 and 17 of the Letter Agreement, which are not hereby superseded. Section 17. Partial Invalidity. In the event that any term, provision ------------------ or covenant herein or the application thereof to any circumstances or situation shall be invalid or unenforceable, in whole or in part, the remainder hereof and the application of said term, provision or covenant to any other circumstance or situation shall not be affected thereby, and each term, provision or covenant herein shall be valid and enforceable to the full extent permitted by law. Section 18. Construction and Waiver of Jury Trial. This Agreement ------------------------------------- shall be construed in accordance with the laws of the State of New York. Each of the Citizens Parties and the Agent waives all right to trial by jury in any action, proceeding, claim or counterclaim (whether based on contract, tort or otherwise) related to or arising out of this Agreement. [REST OF PAGE INTENTIONALLY LEFT BLANK] 33 If the foregoing is in accordance with your understanding of our agreement, please sign and return to us a counterpart hereof, whereupon this instrument along with all counterparts will become a binding agreement between you and us in accordance with its terms. Very truly yours, CITIZENS SOUTH HOLDINGS, MHC By: _____________________________________ Kim S. Price President and Chief Executive Officer CITIZENS SOUTH BANKING CORPORATION By: _____________________________________ Kim S. Price President and Chief Executive Officer CITIZENS SOUTH BANKING CORPORATION (New) By: _____________________________________ Kim S. Price President and Chief Executive Officer CITIZENS SOUTH BANK By: _____________________________________ Kim S. Price President and Chief Executive Officer The foregoing Agency Agreement is hereby confirmed and accepted as of the date first set forth above. KEEFE, BRUYETTE & WOODS, INC. By: ________________________________ Harold T. Hanley III Managing Director 34 EX-2 5 dex2.txt EXHIBIT 2 EXHIBIT 2 PLAN OF CONVERSION AND REORGANIZATION OF CITIZENS SOUTH HOLDINGS, MHC
TABLE OF CONTENTS 1. INTRODUCTION 1 2. DEFINITIONS 1 3. PROCEDURES FOR CONVERSION 7 4. HOLDING COMPANY APPLICATIONS AND APPROVALS 9 5. SALE OF SUBSCRIPTION SHARES 9 6. PURCHASE PRICE AND NUMBER OF SUBSCRIPTION SHARES 10 7. RETENTION OF CONVERSION PROCEEDS BY THE HOLDING COMPANY 11 8. SUBSCRIPTION RIGHTS OF ELIGIBLE ACCOUNT HOLDERS (FIRST PRIORITY) 11 9. SUBSCRIPTION RIGHTS OF EMPLOYEE PLANS (SECOND PRIORITY) 12 10. SUBSCRIPTION RIGHTS OF SUPPLEMENTAL ELIGIBLE ACCOUNT HOLDERS (THIRD PRIORITY) 12 11. SUBSCRIPTION RIGHTS OF OTHER MEMBERS (FOURTH PRIORITY) 13 12. COMMUNITY OFFERING 13 13. SYNDICATED COMMUNITY OFFERING 14 14. LIMITATIONS ON PURCHASES 14 15. PAYMENT FOR HOLDING COMPANY COMMON STOCK 16 16. MANNER OF EXERCISING SUBSCRIPTION RIGHTS THROUGH ORDER FORMS 17 17. UNDELIVERED, DEFECTIVE OR LATE ORDER FORM; INSUFFICIENT PAYMENT 18 18. RESIDENTS OF FOREIGN COUNTRIES AND CERTAIN STATES 18 19. ESTABLISHMENT OF LIQUIDATION ACCOUNT 19 20. VOTING RIGHTS OF STOCKHOLDERS 20 21. RESTRICTIONS ON RESALE OR SUBSEQUENT DISPOSITION 20 22. REQUIREMENTS FOR STOCK PURCHASES BY DIRECTORS AND OFFICERS FOLLOWING THE CONVERSION 21 23. TRANSFER OF DEPOSIT ACCOUNTS 21 24. REGISTRATION AND MARKETING 21 25. TAX RULINGS OR OPINIONS 21 26. STOCK BENEFIT PLANS AND EMPLOYMENT AGREEMENTS 22 27. RESTRICTIONS ON ACQUISITION OF BANK AND HOLDING COMPANY 23 28. PAYMENT OF DIVIDENDS AND REPURCHASE OF STOCK 24 29. CHARTER AND BYLAWS 24 30. CONSUMMATION OF CONVERSION AND EFFECTIVE DATE 24 31. EXPENSES OF CONVERSION 24 32. AMENDMENT OR TERMINATION OF PLAN 24 33. CONDITIONS TO CONVERSION 25 34. INTERPRETATION 25
EXHIBIT A AGREEMENT OF MERGER BETWEEN CITIZENS SOUTH BANKING CORPORATION, CITIZENS SOUTH INTERIM SAVINGS BANK I AND CITIZENS SOUTH BANK EXHIBIT B AGREEMENT OF MERGER BETWEEN CITIZENS SOUTH HOLDINGS, MHC, CITIZENS SOUTH INTERIM SAVINGS BANK II AND CITIZENS SOUTH BANK EXHIBIT C AGREEMENT OF MERGER BETWEEN CITIZENS SOUTH BANK AND CITIZENS SOUTH INTERIM SAVINGS BANK EXHIBIT D CERTIFICATE OF INCORPORATION OF THE HOLDING COMPANY EXHIBIT E BYLAWS OF THE HOLDING COMPANY PLAN OF CONVERSION AND REORGANIZATION OF CITIZENS SOUTH HOLDINGS, MHC 1. INTRODUCTION This Plan of Conversion and Reorganization (the "Plan") provides for the conversion of Citizens South Holdings, MHC, a federal mutual holding company (the "Mutual Holding Company"), into the capital stock form of organization. The Mutual Holding Company currently owns a majority of the common stock of Citizens South Banking Corporation, a federal stock holding company (the "Mid-Tier Holding Company"), which owns 100% of the common stock of Citizens South Bank (the "Bank"), a federal stock savings bank which is headquartered in Gastonia, North Carolina. The purpose of the Conversion is to provide the Bank and its stock holding company resulting from the conversion (the "Holding Company") with greater operating flexibility and capital resources to respond to changing regulatory and market conditions, and to effect corporate transactions, including mergers and acquisitions. The Holding Company will offer for sale Holding Company Common Stock upon the terms and conditions set forth herein to Eligible Account Holders, the Employee Plans established by the Bank or the Holding Company, Supplemental Eligible Account Holders and Other Members according to the respective priorities set forth in this Plan. Any shares not subscribed for by the foregoing classes of Persons will be offered for sale to certain members of the public directly by the Holding Company through a Community Offering or a Syndicated Community Offering or through an underwritten firm commitment public offering, or through a combination thereof. As part of the Conversion, each Minority Stockholder will receive Holding Company Common Stock in exchange for Minority Shares. The Conversion will result in the voting interests of the Mutual Holding Company's Members being transferred to Persons who purchase Holding Company Common Stock in the Offering. The Conversion will have no impact on depositors, borrowers or other customers of the Bank. After the Conversion, the Bank will continue to be regulated by the OTS as its chartering authority. The Bank also will continue to be a member of the Federal Home Loan Bank System and all insured savings deposits in the Bank will continue to be insured by the FDIC to the extent provided by applicable law. This Plan has been adopted by the Boards of Directors of the Mutual Holding Company, the Mid-Tier Holding Company and the Bank and must also be approved by (i) a majority of the total number of votes entitled to be cast by Voting Members of the Mutual Holding Company at a Special Meeting of Members to be called for that purpose, and (ii) at least two-thirds of the outstanding common stock of Mid-Tier Holding Company at the Special Meeting of Stockholders, including at least a majority of the votes cast, in person or by proxy, by Minority Stockholders. Prior to presenting this Plan to the Voting Members and stockholders of Mid-Tier Holding Company for consideration, the Plan must be approved by the OTS. 2. DEFINITIONS For the purposes of this Plan, the following terms have the following meanings: Account Holder - Any Person holding a Deposit Account in the Bank. Acting in Concert - The term Acting in Concert means (i) knowing participation in a joint activity or interdependent conscious parallel action towards a common goal whether or not pursuant to an express agreement; or (ii) a combination or pooling of voting or other interests in the securities of an issuer for a common purpose pursuant to any contract, understanding, relationship, agreement or other arrangement, whether written or otherwise. A Person or company which acts in concert with another Person or company ("other party") shall also be deemed to be acting in concert with any Person or company who is also acting in concert with that other party, except that any Tax-Qualified Employee Stock Benefit Plan will not be deemed to be acting in concert with its trustee or a Person who serves in a similar capacity solely for the purpose of determining whether stock held by the trustee and stock held by the plan will be aggregated. Affiliate - Any Person that controls, is controlled by, or is under common control with another Person. Appraised Value Range - The range of the estimated consolidated pro forma market value of the Holding Company, which shall also be equal to the estimated pro forma market value of the total number of shares of Holding Company Common Stock to be issued in the Conversion, as determined by the Independent Appraiser prior to the Subscription Offering and as it may be amended from time to time thereafter. The maximum and minimum of the Appraised Value Range will vary within 15% above and 15% below, respectively, of the midpoint of the Appraised Value Range. Associate - The term Associate when used to indicate a relationship with any Person, means (i) any corporation or organization (other than Mid-Tier Holding Company, the Bank or a majority owned subsidiary of the Bank) of which such Person is an officer or partner or is, directly or indirectly, the beneficial owner of 10% or more of any class of equity securities, (ii) any trust or other estate in which such Person has a substantial beneficial interest or as to which such Person serves as trustee or in a similar fiduciary capacity, except that for the purposes of this Plan relating to subscriptions in the Offering the term "Associate" does not include any non-Tax-Qualified Employee Stock Benefit Plan or any Tax-Qualified Employee Stock Benefit Plan in which a Person has a substantial beneficial interest or serves as a trustee or in a similar fiduciary capacity, and except that for purposes of aggregating total shares that may be held by Officers and Directors the term "Associate" does not include any shares held for the benefit of such Persons through any Tax-Qualified Employee Stock Benefit Plan, and (iii) any relative or spouse of such Person, or any relative of such spouse, who has the same home as such Person or who is a Director or Officer of Mid-Tier Holding Company, the Bank or the Holding Company, or any of their parents or subsidiaries. Bank - Citizens South Bank. Bank Merger - The merger of Interim with the Bank as set forth in this Plan. Code - The Internal Revenue Code of 1986, as amended. Community - The North Carolina Counties of Gaston, Rowan, Iredell, Mecklenburg, Cabarrus, Cleveland and Lincoln, and the South Carolina County of York. 2 Community Offering - The offering for sale to certain members of the general public directly by the Holding Company of shares not subscribed for in the Subscription Offering. Control - (including the terms "controlled by", "controlling" and "under common control with") means the possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of a Person, whether through the ownership of voting securities, by contract or otherwise. Conversion - The conversion and reorganization of the Mutual Holding Company to stock form pursuant to this Plan, and all steps incident or necessary thereto, include the Exchange Offer and the Offering. Deposit Account - Any withdrawable account as defined in Section 561.42 of the Rules and Regulations of the OTS, and shall include all demand deposit accounts and certificates of deposit. Director - A member of the Board of Directors of the Bank, Mid-Tier Holding Company, the Holding Company or the Mutual Holding Company, as appropriate in the context. Eligible Account Holder - Any Person holding a Qualifying Deposit on the Eligibility Record Date for purposes of determining subscription rights and establishing subaccount balances in the Liquidation Account. Eligibility Record Date - The date for determining Eligible Account Holders, which is March 31,2001. Employees - All Persons who are employed by the Bank, Mid-Tier Holding Company or the Mutual Holding Company. Employee Plans - Any Tax-Qualified Employee Stock Benefit Plan of the Bank or the Holding Company, including any ESOP and 401(k) Plan. ESOP - An Employee Stock Ownership Plan and related trust established by the Bank or the Holding Company. Exchange Offer - The offer of Holding Company Common Stock to Minority Stockholders in exchange for Minority Shares. Exchange Ratio - The rate at which shares of Holding Company Common Stock are exchanged for Minority Shares upon consummation of the Conversion. The Exchange Ratio shall be determined as of the closing of the Conversion and shall be the rate that will result in the Minority Stockholders owning in the aggregate the same percentage of the outstanding shares of Holding Company Common Stock immediately upon completion of the Conversion (without giving effect to any shares purchased in the Offering and any cash issued in lieu of fractional shares), as the percentage of Mid-Tier Holding Company common stock owned by them in the aggregate immediately prior to the consummation of the Conversion. 3 Exchange Shares - Shares of Holding Company Common Stock issued to Minority Stockholders in exchange for Minority Shares. FDIC - The Federal Deposit Insurance Corporation. Holding Company - The Delaware corporation formed for the purpose of acquiring all of the shares of capital stock of the Bank in connection with the Conversion. The Holding Company will be the successor to Mid-Tier Holding Company. Shares of Holding Company Common Stock will be issued in the Conversion to Participants and others in the Conversion. Holding Company Common Stock - The common stock, par value $.01 per share, of the Holding Company. Independent Appraiser - The appraiser retained by the Mutual Holding Company and the Bank to prepare an appraisal of the pro forma market value of the Holding Company Common Stock issued in the Conversion. Interim - The interim federal savings bank subsidiary of the Holding Company established to effect the Conversion. Liquidation Account - One or more accounts established in accordance with 12 C.F.R. 563b.3(f) and OTS policy. Majority Ownership Interest - The percentage of common stock of Mid-Tier Holding Company owned by the Mutual Holding Company immediately prior to the completion of the Conversion. Member - Any Person or entity who qualifies as a member of the Mutual Holding Company pursuant to its charter and bylaws. MHC Merger - The conversion of the Mutual Holding Company into an interim federal stock savings bank and subsequent merger with and into the Bank as set forth in this Plan. Mid-Tier Holding Company - Citizens South Banking Corporation, the Federal holding company that owns 100% of the Bank's common stock, and any successor thereto. Mid-Tier Merger - The conversion of Mid-Tier Holding Company into an interim federal stock savings bank and subsequent merger with and into the Bank as set forth in this Plan. Minority Share(s) - Any outstanding common stock of the Mid-Tier Holding Company, or shares of common stock of the Mid-Tier Holding Company issuable upon the exercise of options or grant of stock awards, in each case held by persons other than the Mutual Holding Company. Minority Stockholder - Any owner of Minority Shares. Mutual Holding Company - Citizens South Holdings, MHC, the mutual holding company of the Bank. 4 OTS - The Office of Thrift Supervision of the Department of the Treasury or any successor thereto. Offering - The offering for sale, pursuant to this Plan, of Holding Company Common Stock in a Subscription Offering, Community Offering, and Syndicated Community Offering (or underwritten public offering), as the case may be. The term "Offering" does not include the Holding Company Common Stock issued in exchange for Minority Shares pursuant to this Plan. Offering Range - The number of shares of Holding Company Stock offered for sale in the Offering multiplied by the Subscription Price. The Offering Range shall be equal to the Appraised Value Range multiplied by the Majority Ownership Interest. Officer - An executive officer of the Bank, the Mid-Tier Holding Company, the Holding Company or the Mutual Holding Company as appropriate in the context, which includes the Chief Executive Officer, President, Senior Vice Presidents, Executive Vice President in charge of principal business functions, Secretary and Controller and any Person performing functions similar to those performed by the foregoing persons. Order Form - Any form (together with any cover letter and/or certifications or acknowledgments), sent by the Bank to any Participant or Person containing among other things a description of the alternatives available to such Person under the Plan and by which any such Person may make elections regarding purchases of Holding Company Common Stock in the Subscription and Community Offerings. Other Member - Any Member on the Voting Record Date who is not an Eligible Account Holder or Supplemental Eligible Account Holder. Participant - Any Eligible Account Holder, Employee Plan, Supplemental Eligible Account Holder, or Other Member. Person - An individual, a corporation, a partnership, an association, a joint stock company, a trust (including Individual Retirement Accounts and KEOGH Accounts), any unincorporated organization, a government or political subdivision thereof or any other entity. Plan - This Plan of Conversion and Reorganization of the Mutual Holding Company as it exists on the date hereof and as it may hereafter be amended in accordance with its terms. Prospectus - The one or more documents used in offering the Holding Company Common Stock in the Offering and the Exchange Offer. Qualifying Deposit - The aggregate balance of all Deposit Accounts in the Bank of (i) an Eligible Account Holder at the close of business on the Eligibility Record Date, provided such aggregate balance is not less than $50, and (ii) a Supplemental Eligible Account Holder at the close of business on the Supplemental Eligibility Record Date, provided such aggregate balance is not less than $50. 5 Resident - Any Person who occupies a dwelling within the Community, has a present intent to remain within the Community for a period of time, and manifests the genuineness of that intent by establishing an ongoing physical presence within the Community together with an indication that such presence within the Community is something other than merely transitory in nature. To the extent the Person is a corporation or other business entity, the principal place of business or headquarters shall be in the Community. To the extent a Person is a personal benefit plan, the circumstances of the beneficiary shall apply with respect to this definition. In the case of all other benefit plans, circumstances of the trustee shall be examined for purposes of this definition. The Bank may utilize deposit or loan records or such other evidence provided to it to make a determination as to whether a Person is a resident. In all cases, however, such a determination shall be in the sole discretion of the Mutual Holding Company and the Bank. A Participant or Person must be a "Resident" for purposes of determining whether such Person "resides" or is "residing" in the Community as such term is used in this Plan. SEC - The Securities and Exchange Commission. Special Meeting of Members - The special meeting of Members of the Mutual Holding Company and any adjournments thereof held to consider and vote upon this Plan. Special Meeting of Stockholders - The special meeting of stockholders of the Mid-Tier Holding Company and any adjournments thereof held to consider and vote upon the Plan. Subscription Offering - The offering of Subscription Shares to Participants. Subscription Price - The price per Subscription Share to be paid by Participants in the Subscription Offering and by Persons in the Community Offering and any Syndicated Community Offering. The Subscription Price will be determined by the Board of Directors of the Mutual Holding Company and fixed prior to the commencement of the Subscription Offering. Subscription Shares - Shares of Holding Company Common Stock issued in the Subscription Offering. Subscription Shares do not include Exchange Shares. Supplemental Eligible Account Holder - Any Person, other than Directors and Officers of the Bank, the Mid-Tier Holding Company or the Mutual Holding Company and their Associates, holding a Qualifying Deposit on the Supplemental Eligibility Record Date, who is not an Eligible Account Holder. Supplemental Eligibility Record Date - The date for determining Supplemental Eligible Account Holders, which shall be the last day of the calendar quarter preceding OTS approval of the application for conversion. Syndicated Community Offering - The offering of Holding Company Common Stock following the Subscription and Community Offerings through a syndicate of broker-dealers. Tax-Qualified Employee Stock Benefit Plan - Any defined benefit plan or defined contribution plan, such as an employee stock ownership plan, stock bonus plan, profit-sharing plan or other plan, which, with its related trust, meets the requirements to be "qualified" under 6 Section 401 of the Internal Revenue Code. The Bank may make scheduled discretionary contributions to a tax-qualified employee stock benefit plan, provided such contributions do not cause the Bank to fail to meet its regulatory capital requirement. A "non-Tax-Qualified Employee Stock Benefit Plan" is any defined benefit plan or defined contribution plan which is not so qualified. Voting Member - Any Person who at the close of business on the Voting Record Date is entitled to vote as a Member of the Mutual Holding Company pursuant to its charter and bylaws. Voting Record Date - The date fixed by the Directors in accordance with OTS regulations for determining eligibility to vote at the Special Meeting of Members and/or the Special Meeting of Stockholders. 3. PROCEDURES FOR CONVERSION A. After approval of the Plan by the Boards of Directors of the Bank, the Mid-Tier Holding Company and the Mutual Holding Company, the Plan together with all other requisite material shall be submitted to the OTS for its approval. Notice of the adoption of the Plan by the Boards of Directors of the Bank and the Mutual Holding Company and the submission of the Plan to the OTS for its approval will be published in a newspaper having general circulation in each community in which an office of the Bank is located, and copies of the Plan will be made available at each office of the Bank for inspection by the Members. Upon receipt of notice from the OTS to do so, the Mutual Holding Company also will publish a notice of the filing with the OTS of an application to convert in accordance with the provisions of this Plan. B. Promptly following approval by the OTS, the Plan will be submitted to a vote of (i) the Voting Members at the Special Meeting of Members, and (ii) the Stockholders of the Mid-Tier Holding Company at the Special Meeting of Stockholders. The Mutual Holding Company will mail to all Members as of the Voting Record Date, at their last known address appearing on the records of the Bank at that date, a proxy statement in either long or summary form describing the Plan which will be presented to a vote of the Members at the Special Meeting of Members. The Mid-Tier Holding Company also will mail to all stockholders as of the Voting Record Date, a proxy statement describing the Plan and the Conversion, which will be presented to a vote of stockholders at the Special Meeting of Stockholders. The Holding Company will also mail to all Participants either a Prospectus and Order Form for the purchase of Subscription Shares or a letter informing them of their right to receive a Prospectus and Order Form and a postage prepaid card to request such materials, subject to other provisions of this Plan. In addition, all Participants will receive, or be given the opportunity to request by either returning a postage prepaid card which may be distributed with the proxy statement or by letter addressed to the Bank's Secretary, a copy of the Plan as well as the certificate of incorporation or bylaws of the Holding Company. Upon approval of the Plan by (i) a majority of the total number of votes entitled to be cast by the Voting Members, (ii) at least two-thirds of the outstanding common stock of the Mid-Tier Holding Company, and (iii) a majority vote of Minority Stockholders present in person or by proxy, the Mutual Holding Company, the Holding Company and the Bank will take all other necessary steps pursuant to applicable laws and regulations to consummate the Conversion and Offering. The Conversion must be completed within 24 months of the approval of the Plan by the Voting Members, unless a longer time period is permitted by governing laws and regulations. 7 C. The Conversion will be effected as follows or in any other manner selected by the Board of Directors of the Mutual Holding Company which is consistent with the purposes of this Plan and applicable laws and regulations. The choice of which method to use to effect the Conversion will be made by the Board of Directors of the Mutual Holding Company immediately prior to the closing of the Conversion. Each of the steps shall be deemed to occur in the order set forth below or in such order as is necessary to consummate the Conversion pursuant to the Plan, the intent of the Boards of Directors of the Mutual Holding Company, the Mid-Tier Holding Company and the Bank, and OTS regulations. Approval of the Plan by the Members and by the stockholders of the Mid-Tier Holding Company shall also constitute approval of each of the transactions below that are necessary to implement the Plan. (1) The Mid-Tier Holding Company will convert into or exchange its charter for an interim federal stock savings bank (which shall continue to be referred to as the "Mid-Tier Holding Company") and will merge with and into the Bank (the "Mid-Tier Merger") with the Bank as the resulting entity, pursuant to the Agreement of Merger attached hereto as Exhibit A, whereby the Mid-Tier Holding Company stockholders will constructively receive shares of Bank common stock in exchange for their Mid-Tier Holding Company common stock. (2) The Mutual Holding Company will exchange its charter for an interim federal stock savings bank charter and simultaneously merge with and into the Bank (the "MHC Merger") pursuant to the Agreement of Merger attached hereto as Exhibit B between the Mutual Holding Company and the Bank, whereby the shares of common stock of the Bank constructively held by the Mutual Holding Company will be canceled and each Eligible Account Holder and Supplemental Eligible Account Holder will receive an interest in a Liquidation Account of the Bank in exchange for such person's interest in the Mutual Holding Company. (3) The Bank will establish the Holding Company as a first-tier stock holding company subsidiary. (4) Immediately after the MHC Merger, the Holding Company will charter Interim as a wholly-owned subsidiary. (5) Immediately after the formation of Interim, Interim will merge with and into the Bank with the Bank as the surviving entity (the "Bank Merger") pursuant to the Agreement of Merger attached hereto as Exhibit C between the Bank and Interim, whereby the Holding Company will become the sole stockholder of the Bank. Constructive shareholders of the Bank (i.e., Minority Stockholders) will exchange the shares of Bank common stock that they constructively received in the Mid-Tier Merger for Holding Company Common Stock. (6) Contemporaneously with the Bank Merger, the Holding Company will offer for sale its Common Stock in the Offering. 8 D. As part of the Conversion, each Minority Share shall automatically, without further action of the holder thereof, be converted into and become the right to receive Holding Company Common Stock based upon the Exchange Ratio. The basis for exchange of Minority Shares for Holding Company Common Stock shall be fair and reasonable. Options to purchase shares of Mid-Tier Holding Company common stock which are outstanding immediately prior to the consummation of the Conversion shall be converted into options to purchase shares of Holding Company Common Stock, with the number of shares subject to the option and the exercise price per share to be adjusted based upon the Exchange Ratio so that the aggregate exercise price remains unchanged, and with the duration of the option remaining unchanged. E. Concurrent with the filing of the Conversion application with the OTS, the Holding Company shall also seek to register the Holding Company Common Stock with the SEC and any appropriate state securities authorities. In addition, the Mid-Tier Holding Company shall prepare preliminary proxy materials as well as other applications and information for review by the SEC and the OTS in connection with the solicitation of stockholder approval of the Plan. F. The Certificate of Incorporation of the Holding Company (the "Certificate") shall read substantially in the form of Exhibit D. G. The home office and branch offices of the Bank shall be unaffected by the Conversion. The executive offices of the Holding Company shall be located at the current offices of the Mutual Holding Company. 4. HOLDING COMPANY APPLICATIONS AND APPROVALS The Board of Directors of the Mid-Tier Holding Company, the Bank and the Mutual Holding Company will take all necessary steps to convert the Mutual Holding Company to stock form, form the Holding Company and complete the Offering. The Holding Company shall make timely applications for any requisite regulatory approvals, including an Application on Form AC and a Holding Company Application on Form H-(e)1 or Form H-(e)1-S, to be filed with the OTS and a Registration Statement to be filed with the SEC. 5. SALE OF SUBSCRIPTION SHARES The Subscription Shares will be offered simultaneously in the Subscription Offering to the Participants in the respective priorities set forth in this Plan. Subscription Shares will be available for purchase only in the priorities set forth in this Plan. The Subscription Offering may begin as early as the mailing of the proxy statement for the Special Meeting of Members. The Holding Company Common Stock will not be insured by the FDIC. The Bank will not knowingly lend funds or otherwise extend credit to any Person to purchase shares of Holding Company Common Stock. Any Subscription Shares not subscribed for in the Subscription Offering may be offered for sale in the Community Offering. The Subscription Offering may begin prior to the Special Meeting of Members and, in that event, the Community Offering may also begin prior to the Special Meeting of Members. The offer and sale of Holding Company Common Stock prior to the Special Meeting of 9 Members will, however, be conditioned upon approval of the Plan by the Voting Members and stockholders of the Mid-Tier Holding Company. If feasible, any shares of Holding Company Common Stock remaining after the Subscription and Community Offerings, will be offered for sale in a Syndicated Community Offering or underwritten public offering in a manner that will achieve the widest distribution of the Holding Company Common Stock. The sale of all Holding Company Common Stock purchased in the Subscription and Community Offerings will be consummated simultaneously with the sale of any Holding Company Common Stock in the Syndicated Community Offering or underwritten public offering. 6. PURCHASE PRICE AND NUMBER OF SUBSCRIPTION SHARES The total number of shares (or a range thereof) of Holding Company Common Stock to be offered for sale in the Offering will be determined jointly by the Boards of Directors of the Mid-Tier Holding Company and the Holding Company immediately prior to the commencement of the Subscription and Community Offerings, and will be equal to the Offering Range divided by the Subscription Price. The Offering Range will be equal to the Appraised Value Range multiplied by the Majority Ownership Interest. The estimated pro forma consolidated market value of the Holding Company will be subject to adjustment within the Appraised Value Range if necessitated by market or financial conditions, with the approval of the OTS, if necessary, and the maximum of the Appraised Value Range may be increased by up to 15% subsequent to the commencement of the Subscription and Community Offerings to reflect changes in market and financial conditions. The number of shares of Holding Company Common Stock issued in the Conversion will be equal to the estimated pro forma consolidated market value of the Holding Company, as may be amended, divided by the Subscription Price, and the number of shares of Holding Company Common Stock sold in the Offering will be equal to the product of (i) the estimated pro forma consolidated market value of the Holding Company, as may be amended, divided by the Subscription Price, and (ii) the Majority Ownership Interest. In the event that the Subscription Price multiplied by the number of shares of Holding Company Common Stock to be issued in the Conversion is below the minimum of the Appraised Value Range, or materially above the maximum of the Appraised Value Range, a resolicitation of purchasers may be required, provided that up to a 15% increase above the maximum of the Appraised Value Range will not be deemed material so as to require a resolicitation. Any such resolicitation shall be effected in such manner and within such time as the Bank and the Mutual Holding Company shall establish, with the approval of the OTS if required. Notwithstanding the foregoing, shares of Holding Company Common Stock will not be issued unless, prior to the consummation of the Conversion, the Independent Appraiser confirms to the Bank, the Mutual Holding Company, the Holding Company and to the OTS that, to the best knowledge of the Independent Appraiser, nothing of a material nature has occurred which, taking into account all relevant factors, would cause the Independent Appraiser to conclude that the number of shares of Holding Company Common Stock issued in the Conversion multiplied by the Subscription Price is incompatible with its estimate of the aggregate pro forma consolidated market value of the Holding Company. An increase in the aggregate value of the Holding Company 10 Common Stock by up to 15% above the maximum of the Appraised Value Range, would not be deemed to be material. If such confirmation is not received, the Holding Company may cancel the Offering, extend the Conversion, establish a new Subscription Price and/or Appraised Value Range and reopen or hold a new Offering, or take such other action as the OTS may permit. The Holding Company Common Stock to be issued in the Conversion shall be fully paid and nonassessable. 7. RETENTION OF CONVERSION PROCEEDS BY THE HOLDING COMPANY The Holding Company will apply to the OTS to retain up to 50% of the proceeds of the Offering. The Holding Company believes that the Offering proceeds will provide economic strength to the Holding Company and the Bank in a highly competitive financial services industry, and would facilitate the possible expansion through acquisitions of other financial institutions, possible diversification into other related businesses and for other business and investment purposes, including the possible payment of dividends and future repurchases of the Holding Company Common Stock. 8. SUBSCRIPTION RIGHTS OF ELIGIBLE ACCOUNT HOLDERS (FIRST PRIORITY) A. Each Eligible Account Holder shall receive, without payment, nontransferable subscription rights to subscribe in the Subscription Offering for a number of shares equal to up to the greater of 50,000 shares, .10% of the total number of shares of Holding Company Common Stock issued in the Offering, or fifteen times the product (rounded down to the next whole number) obtained by multiplying the total number of shares of Holding Company Common Stock issued in the Offering by a fraction, the numerator of which is the amount of the Eligible Account Holder's Qualifying Deposit and the denominator is the total amount of Qualifying Deposits of all Eligible Account Holders, in each case on the Eligibility Record Date, subject to the provisions of Section 14. B. In the event that Eligible Account Holders exercise subscription rights for a number of Subscription Shares in excess of the total number of such shares eligible for subscription, the Subscription Shares shall be allocated among the subscribing Eligible Account Holders so as to permit each subscribing Eligible Account Holder to purchase a number of shares sufficient to make his or her total allocation of Subscription Shares equal to the lesser of 100 shares or the number of shares for which such Eligible Account Holder has subscribed. Any remaining shares will be allocated among the subscribing Eligible Account Holders whose subscriptions remain unsatisfied in the proportion that the amount of the Qualifying Deposit of each Eligible Account Holder whose subscription remains unsatisfied bears to the total amount of the Qualifying Deposits of all Eligible Account Holders whose subscriptions remain unsatisfied. If the amount so allocated exceeds the amount subscribed for by any one or more Eligible Account Holders, the excess shall be reallocated (one or more times as necessary) among those Eligible Account Holders whose subscriptions are still not fully satisfied on the same basis until all available shares have been allocated. C. Subscription rights of Directors, Officers and their Associates as Eligible Account Holders which are based on deposits made by such Persons during the twelve (12) months preceding 11 the Eligibility Record Date shall be subordinated to the subscription rights of all other Eligible Account Holders. 9. SUBSCRIPTION RIGHTS OF EMPLOYEE PLANS (SECOND PRIORITY) If Subscription Shares remain available after all subscriptions of Eligible Account Holders have been satisfied, the Employee Plans of the Holding Company and the Bank shall receive, without payment, subscription rights to purchase in the aggregate up to 10% of the total number of shares of Holding Company Common Stock issued in the Offering. The Employee Plans may purchase any shares of Holding Company Common Stock to be issued in the Offering as a result of an increase in the maximum of the Appraised Value Range after commencement of the Subscription Offering and prior to completion of the Conversion, notwithstanding the subscription rights of Eligible Account Holders. Consistent with applicable laws and regulations and practices and policies of the OTS, the Employee Plans may use funds contributed by the Holding Company or the Bank and/or borrowed from an independent financial institution to exercise such subscription rights, and the Holding Company and the Bank may make scheduled discretionary contributions thereto, provided that such contributions do not cause the Holding Company or the Bank to fail to meet any applicable regulatory capital requirements. The Employee Plans shall not be deemed to be Associates or Affiliates of or Persons Acting in Concert with any Director or Officer of the Holding Company or the Bank. 10. SUBSCRIPTION RIGHTS OF SUPPLEMENTAL ELIGIBLE ACCOUNT HOLDERS (THIRD PRIORITY) A. Each Supplemental Eligible Account Holder shall receive, without payment, nontransferable subscription rights to subscribe in the Subscription Offering for a number of shares equal to up to the greater of 50,000 shares, ...10% of the total number of shares of Holding Company Common Stock issued in the Offering, or fifteen times the product (rounded down to the next whole number) obtained by multiplying the total number of shares of Holding Company Common Stock issued in the Offering by a fraction, the numerator of which is the amount of the Supplemental Eligible Account Holder's Qualifying Deposit and the denominator is the total amount of Qualifying Deposits of all Supplemental Eligible Account Holders, in each case on the Supplemental Eligibility Record Date, subject to the availability of sufficient shares after filling in full all subscription orders of the Eligible Account Holders and Employee Plans and to the purchase limitations specified in Section 14. B. In the event that Supplemental Eligible Account Holders exercise subscription rights for a number of Subscription Shares in excess of the total number of such shares eligible for subscription, the Subscription Shares shall be allocated among the subscribing Supplemental Eligible Account Holders so as to permit each such subscribing Supplemental Eligible Account Holder, to the extent possible, to purchase a number of shares sufficient to make his or her total allocation of Subscription Shares equal to the lesser of 100 shares or the number of shares for which each such Supplemental Eligible Account Holder has subscribed. Any remaining shares will be allocated among the subscribing Supplemental Eligible Account Holders whose subscriptions remain unsatisfied in the proportion that the amount of the Qualifying Deposit of each such Supplemental Eligible Account Holder bears to the total amount of the Qualifying Deposits of all Supplemental 12 Eligible Account Holders whose subscriptions remain unsatisfied. If the amount so allocated exceeds the amount subscribed for by any one or more Supplemental Eligible Account Holders, the excess shall be reallocated (one or more times as necessary) among those Supplemental Eligible Account Holders whose subscriptions are still not fully satisfied on the same basis until all available shares have been allocated or all subscriptions satisfied. 11. SUBSCRIPTION RIGHTS OF OTHER MEMBERS (FOURTH PRIORITY) A. Each Other Member shall receive, without payment, nontransferable subscription rights to subscribe in the Subscription Offering for a number of Subscription Shares equal to up to the greater of 50,000 shares, or .10% of the total number of shares of Holding Company Common Stock issued in the Offering, subject to the availability of sufficient shares after filling in full all subscription orders of Eligible Account Holders, Employee Plans and Supplemental Eligible Account Holders and to the purchase limitations specified in Section 14. B. In the event that such Other Members subscribe for a number of Subscription Shares which, when added to the Subscription Shares subscribed for by the Eligible Account Holders, Employee Plans and Supplemental Eligible Account Holders, is in excess of the total number of Subscription Shares to be issued, the subscriptions of such Other Members will be allocated to Other Members in proportion to the amounts of their relative subscriptions. 12. COMMUNITY OFFERING If less than the total number of shares of Holding Company Common Stock to be sold in the Offering are subscribed for in the Subscription Offering, shares remaining unsubscribed for may be made available for purchase in the Community Offering to members of the general public. In the Community Offering, any Person may purchase up to 50,000 shares, subject to the overall purchase limitations specified in Section 14. The shares may be made available in the Community Offering through a direct community marketing program which may provide for a broker, dealer, consultant or investment banking firm experienced and expert in the sale of savings institutions securities. Such entities may be compensated on a fixed fee basis or on a commission basis, or a combination thereof. In the event orders for Holding Company Common Stock in the Community Offering exceed the number of shares available for sale, shares may be allocated (to the extent shares remain available) first to cover orders of Minority Stockholders as of the Voting Record Date, next to cover orders of natural persons residing in the Community, and thereafter to cover orders of other members of the general public. In the event orders for Holding Company Common Stock in any of these categories exceed the number of shares available for sale, shares any be allocated on a pro rata basis within a category based on the amount of the respective orders. The Holding Company shall make the distribution of the Holding Company Common Stock to be sold in the Community Offering in such a manner as to promote a wide distribution of the Holding Company Common Stock. The Holding Company reserves the right to reject any or all orders, in whole or in part, which are received in the Community Offering. 13 13. SYNDICATED COMMUNITY OFFERING If feasible, the Board of Directors may determine to offer for sale in a Syndicated Community Offering shares of Holding Company Common Stock not purchased in the Subscription and Community Offerings, subject to such terms, conditions and procedures as may be determined by the Holding Company, in a manner that will achieve the widest distribution of the Holding Company Common Stock, subject to the right of the Bank to accept or reject in whole or in part any subscriptions in the Syndicated Community Offering. In the Syndicated Community Offering, any Person may purchase up to 50,000 shares, subject to the maximum purchase limitations specified in Section 14. Provided the Subscription Offering has begun, the Bank may begin the Syndicated Community Offering at any time after the mailing to the Members of the proxy statement to be used in connection with the Special Meeting of Members, provided that the completion of the offer and sale of Holding Company Common Stock in the Conversion shall be conditioned upon the approval of this Plan by the Voting Members. If the Syndicated Community Offering does not begin pursuant to the provisions of the preceding sentence, the Syndicated Community Offering will begin as soon as practicable following the date upon which the Subscription and Community Offerings terminate. Alternatively, if a Syndicated Community Offering is not held, the Bank shall have the right to sell any shares of Holding Company Common Stock remaining following the Subscription and Community Offerings in an underwritten firm commitment public offering. The provisions of Section 14 shall not be applicable to sales to underwriters for purposes of such an offering but shall be applicable to the sales by the underwriters to the public. The price to be paid by the underwriters in such an offering shall be equal to the Subscription Price less an underwriting discount to be negotiated among such underwriters and the Bank, which will in no event exceed an amount deemed to be acceptable by the OTS. If for any reason a Syndicated Community Offering or an underwritten firm commitment public offering of shares of Holding Company Common Stock not sold in the Subscription and Community Offerings cannot be effected, or in the event that any insignificant residue of shares of Holding Company Common Stock is not sold in the Subscription and Community Offerings or in the Syndicated Community or underwritten firm commitment public offering, other arrangements will be made for the disposition of unsubscribed shares by the Bank, if possible. Such other purchase arrangements will be subject to the approval of the OTS. 14. LIMITATIONS ON PURCHASES The following limitations shall apply to all purchases of shares of Holding Company Common Stock in the Conversion: A. The maximum number of shares of Holding Company Common Stock which may be subscribed for or purchased in all categories in the Offering by any Person or Participant together with any Associate or group of Persons Acting in Concert shall not exceed 50,000 shares of Holding Company Common Stock, except for the Employee Plans which may subscribe for up to 10% of the Holding Company Common Stock issued in the Offering (including shares issued in the event of an increase in the maximum of the Offering Range of up to 15%). 14 B. The maximum number of shares of Holding Company Common Stock which may be purchased in all categories of the Offering by Officers and Directors and their Associates in the aggregate, when combined with Exchange Shares received by such persons, shall not exceed 25% of the shares of Holding Company Common Stock issued in the Conversion. C. A minimum of 25 shares of Holding Company Common Stock must be purchased by each Person purchasing shares in the Offering to the extent those shares are available; provided, however, that in the event the minimum number of shares of Holding Company Common Stock purchased times the price per share exceeds $500, then such minimum purchase requirement shall be reduced to such number of shares which when multiplied by the price per share shall not exceed $500, as determined by the Board. D. The maximum number of shares of Holding Company Common Stock which may be subscribed for or purchased in all categories of the Offering by any Person or Participant together with any Associate or group of Persons Acting in Concert, combined with Exchange Shares received by any such Person or Participant together with any Associate or group of Persons Acting in Concert, shall not exceed 175,000 shares of Holding Company Common Stock, except for the Employee Plans which may subscribe for up to 10% of the shares of Holding Company Common Stock issued in the Offering (including shares issued in the event of an increase in the maximum of the Offering Range of 15%). If the number of shares of Holding Company Common Stock otherwise allocable pursuant to Sections 8 through 13, inclusive, to any Person or that Person's Associates would be in excess of the maximum number of shares permitted as set forth above, the number of shares of Holding Company Common Stock allocated to each group consisting of a Person and that Person's Associates shall be reduced so that the aggregate allocation to that Person and his or her Associates complies with the above limits. Depending upon market or financial conditions, the Board of Directors of the Holding Company, with the approval of the OTS and without further approval of the Members, may decrease or further increase the purchase limitations in this Plan, provided that the maximum purchase limitations may not be increased to a percentage in excess of 5% of the shares issued in the Conversion except as provided below. If the Holding Company increases the maximum purchase limitations, the Holding Company is only required to resolicit Persons who subscribed in the Subscription Offering for the maximum purchase amount and may, in the sole discretion of the Holding Company resolicit certain other large subscribers. In the event that the maximum purchase limitation is increased to 5% of the shares issued in the Conversion, such limitation may be further increased to 9.99%, provided that orders for Holding Company Common Stock exceeding 5% of the shares of Holding Company Common Stock issued in the Conversion shall not exceed in the aggregate 10% of the total shares of Holding Company Common Stock issued in the Conversion. Requests to purchase additional shares of the Holding Company Common Stock in the event that the purchase limitation is so increased will be determined by the Board of Directors of the Holding Company in its sole discretion. In the event of an increase in the total number of shares offered in the Offering due to an increase in the maximum of the Offering Range of up to 15% (the "Adjusted Maximum"), the additional shares will be used in the following order of priority: (i) to fill the Employee Plans' subscription to the Adjusted Maximum; (ii) in the event that there is an 15 oversubscription at the Eligible Account Holder, Supplemental Eligible Account Holder or Other Member levels, to fill unfulfilled subscriptions of such subscribers according to such respective priorities; and (iii) to fill unfulfilled subscriptions in the Community Offering with preference given first to Minority Stockholders as of the Voting Record Date and then to natural persons residing in the Community. For purposes of this Section 14, the Directors of the Bank, the Mid-Tier Holding Company and the Holding Company shall not be deemed to be Associates or a group affiliated with each other or otherwise Acting in Concert solely as a result of their being Directors of the Bank, the Mid-Tier Holding Company, the Mutual Holding Company or the Holding Company. Each Person purchasing Holding Company Common Stock in the Conversion shall be deemed to confirm that such purchase does not conflict with the above purchase limitations contained in this Plan. 15. PAYMENT FOR HOLDING COMPANY COMMON STOCK All payments for Holding Company Common Stock purchased in the Subscription and Community Offerings must be delivered in full to the Holding Company, together with a properly completed and executed Order Form, on or prior to the expiration date of the Offering; provided, however, that if the Employee Plans subscribe for shares during the Subscription Offering, such plans will not be required to pay for the shares at the time they subscribe but rather may pay for such shares of Holding Company Common Stock subscribed for by such plans at the Subscription Price upon consummation of the Conversion. Notwithstanding the foregoing, the Holding Company shall have the right, in its sole discretion, to permit institutional investors to submit contractually irrevocable orders in the Offering and to thereafter submit payment by wire transfer for the Holding Company Common Stock for which they are subscribing in the Offering at any time prior to 48 hours before the completion of the Conversion, unless such 48 hour period is waived by the Holding Company in its sole discretion. Payment for Holding Company Common Stock subscribed for shall be made either by check, money order or bank draft. Alternatively, subscribers in the Subscription and Community Offerings may pay for the shares for which they have subscribed by authorizing the Bank on the Order Form to make a withdrawal from the types of Deposit Accounts at the Bank indicated on the Order Form in an amount equal to the aggregate Subscription Price of such shares. Such authorized withdrawal, whether from a savings passbook or certificate account, shall be without penalty as to premature withdrawal. If the authorized withdrawal is from a certificate account, and the remaining balance does not meet the applicable minimum balance requirement, the certificate shall be canceled at the time of withdrawal, without penalty, and the remaining balance will earn interest at the Bank's passbook rate. Funds for which a withdrawal is authorized will remain in the subscriber's Deposit Account but may not be used by the subscriber during the Offering. Thereafter, the withdrawal will be given effect only to the extent necessary to satisfy the subscription (to the extent it can be filled) at the Subscription Price per share. Interest will continue to be earned on any amounts authorized for withdrawal until such withdrawal is given effect. Interest will be paid by the Bank at the passbook rate on payments for Holding Company Common Stock received by check. Such interest will be paid from the date payment is received by the Bank until consummation or termination of the 16 Conversion. If for any reason the Conversion is not consummated, all payments made by subscribers in the Subscription and Community Offerings will be refunded to them with interest. In case of amounts authorized for withdrawal from Deposit Accounts, refunds will be made by canceling the authorization for withdrawal. The Bank is prohibited by regulation from knowingly making any loans or granting any lines of credit for the purchase of stock in the Conversion, and therefore, will not do so. 16. MANNER OF EXERCISING SUBSCRIPTION RIGHTS THROUGH ORDER FORMS As soon as practicable after the Prospectus prepared by the Holding Company and Bank has been declared effective by the SEC, Order Forms will be distributed to the Eligible Account Holders, Employee Plans, Supplemental Eligible Account Holders and Other Members at their last known addresses as of the most recent eligibility date that appears on the records of the Bank for the purpose of subscribing for shares of Holding Company Common Stock in the Subscription Offering and will be made available for use by Persons in the Community Offering. Notwithstanding the foregoing, the Bank may elect to send Order Forms only to those Persons who request them after receipt of such notice in a form approved by the OTS and which is adequate to apprise the Eligible Account Holders, Employee Plans, Supplemental Eligible Account Holders and Other Members of the pendency of the Subscription Offering. Such notice may be included with the proxy statement for the Special Meeting of Members and the proxy statement for the Special Meeting of Stockholders, and may also be included in the notice of the pendency of the Conversion and the Special Meeting of Members sent to all Eligible Account Holders in accordance with regulations of the OTS. Each Order Form will be preceded or accompanied by a Prospectus describing the Holding Company, the Bank, the Holding Company Common Stock and the Offering. Each Order Form will contain, among other things, the following: A. A specified date by which all Order Forms must be received by the Holding Company, which date shall be not less than twenty (20), nor more than forty-five (45) days, following the date on which the Order Forms are mailed by the Holding Company, and which date will constitute the termination of the Subscription Offering; B. The Subscription Price per share for shares of Holding Company Common Stock to be sold in the Offering; C. A description of the minimum and maximum number of Subscription Shares which may be subscribed for pursuant to the exercise of subscription rights or otherwise purchased in the Community Offering; D. Instructions as to how the recipient of the Order Form is to indicate thereon the number of Subscription Shares for which such person elects to subscribe and the available alternative methods of payment therefor; E. An acknowledgment that the recipient of the Order Form has received a final copy of the Prospectus prior to execution of the Order Form; 17 F. A statement to the effect that all subscription rights are nontransferable, will be void at the end of the Subscription Offering, and can only be exercised by delivering to the Holding Company within the subscription period such properly completed and executed Order Form, together with payment in the full amount of the aggregate purchase price as specified in the Order Form for the shares of Holding Company Common Stock for which the recipient elects to subscribe (or by authorizing on the Order Form that the Bank withdraw said amount from the subscriber's Deposit Account at the Bank); and G. A statement to the effect that the executed Order Form, once received by the Holding Company, may not be modified or amended by the subscriber without the consent of the Holding Company. Notwithstanding the above, the Holding Company reserves the right in its sole discretion to accept or reject orders received on photocopied or facsimiled Order Forms. 17. UNDELIVERED, DEFECTIVE OR LATE ORDER FORM; INSUFFICIENT PAYMENT In the event Order Forms (a) are not delivered and are returned to the Holding Company or the Bank by the United States Postal Service, (b) are not received by the Holding Company or are received by the Holding Company after the expiration date specified thereon, (c) are completed or executed defectively, (d) are not accompanied by the full required payment, or, in the case of institutional investors in the Community Offering, by delivering irrevocable orders together with a legally binding commitment to pay by wire transfer the full amount of the Subscription Price prior to 48 hours before the completion of the Conversion, unless waived by the Holding Company, for the shares of Holding Company Common Stock subscribed or ordered (including cases in which Deposit Accounts from which withdrawals are authorized are insufficient to cover the amount of the required payment), or (e) are not mailed pursuant to a "no mail" order placed in effect by the Account Holder, the subscription rights of the Person to whom such rights have been granted will lapse as though such Person failed to return the completed Order Form within the time period specified thereon; provided, however, that the Holding Company may, but will not be required to, waive any immaterial irregularity on any Order Form or require the submission of corrected Order Forms or the remittance of full payment for subscribed or ordered shares by such date as the Holding Company may specify. The interpretation of the Holding Company of terms and conditions of this Plan and of the Order Forms will be final, subject to the authority of the OTS. 18. RESIDENTS OF FOREIGN COUNTRIES AND CERTAIN STATES The Holding Company will make reasonable efforts to comply with the securities laws of all States in the United States in which Persons entitled to subscribe for shares of Holding Company Common Stock pursuant to this Plan reside. However, no such Person will be issued subscription rights or be permitted to purchase shares of Holding Company Common Stock in the Subscription Offering if such Person resides in a foreign country; or in a State of the United States with respect to which any of the following apply: (A) a small number of Persons otherwise eligible to subscribe for shares under the Plan reside in such state; (B) the issuance of subscription rights or the offer or sale of shares of Holding Company Common Stock to such Persons would require the Holding Company 18 under the securities laws of such state, to register as a broker, dealer, salesman or agent or to register or otherwise qualify its securities for sale in such state; and (C) such registration or qualification would be impracticable for reasons of cost or otherwise. 19. ESTABLISHMENT OF LIQUIDATION ACCOUNT The Bank shall establish at the time of the MHC Merger a Liquidation Account in an amount equal to the greater of: (a) the percentage of the outstanding shares of the common stock of the Mid-Tier Holding Company owned by the Mutual Holding Company prior to the Mid-Tier Merger multiplied by the Mid-Tier Holding Company's total stockholders' equity as reflected in the latest statement of financial condition contained in the final Prospectus utilized in the Conversion; or (b) the retained earnings of the Bank at the time the Bank underwent its mutual holding company reorganization. Following the Conversion, the Liquidation Account will be maintained by the Bank for the benefit of the Eligible Account Holders and Supplemental Eligible Account Holders who continue to maintain their Deposit Accounts at the Bank. Each Eligible Account Holder and Supplemental Eligible Account Holder shall, with respect to his Deposit Account, hold a related inchoate interest in a portion of the Liquidation Account balance, in relation to his Deposit Account balance at the Eligibility Record Date or Supplemental Eligibility Record Date, respectively, or to such balance as it may be subsequently reduced, as hereinafter provided. In the unlikely event of a complete liquidation of the Bank (and only in such event), following all liquidation payments to creditors (including those to Account Holders to the extent of their Deposit Accounts), each Eligible Account Holder and Supplemental Eligible Account Holder shall be entitled to receive a liquidating distribution from the Liquidation Account in the amount of the then adjusted subaccount balance of his Deposit Account then held, before any liquidation distribution may be made to any holders of the Bank's capital stock. No merger, consolidation, purchase of bulk assets with assumption of Deposit Accounts and other liabilities, or similar transactions with an FDIC insured institution, in which the Bank is not the surviving institution, shall be deemed to be a complete liquidation for this purpose. In such transactions, the Liquidation Account shall be assumed by the surviving institution. The initial subaccount balance for a Deposit Account held by an Eligible Account Holder and Supplemental Eligible Account Holder shall be determined by multiplying the opening balance in the Liquidation Account by a fraction, the numerator of which is the amount of the Qualifying Deposits of such Account Holder and the denominator of which is the total amount of all Qualifying Deposits of all Eligible Account Holders and Supplemental Eligible Account Holders. Such initial subaccount balance shall not be increased, but shall be subject to downward adjustment as described below. If, at the close of business on any December 31 annual closing date, commencing on or after the effective date of the Conversion, the deposit balance in the Deposit Account of an Eligible Account Holder or Supplemental Eligible Account Holder is less than the lesser of (i) the balance in the Deposit Account at the close of business on any other annual closing date subsequent to the Eligibility Record Date or Supplemental Eligibility Record Date, or (ii) the amount of the Qualifying Deposit in such Deposit Account as of the Eligibility Record Date or Supplemental Eligibility Record Date, the subaccount balance for such Deposit Account shall be adjusted by reducing such subaccount balance in an amount proportionate to the reduction in such deposit balance. In the event of such downward adjustment, the subaccount balance shall not be subsequently increased, 19 notwithstanding any subsequent increase in the deposit balance of the related Deposit Account. If any such Deposit Account is closed, the related subaccount shall be reduced to zero. The creation and maintenance of the Liquidation Account shall not operate to restrict the use or application of any of the net worth accounts of the Bank, except that the Bank shall not declare or pay a cash dividend on, or repurchase any of, its capital stock if the effect thereof would cause its net worth to be reduced below (i) the amount required for the Liquidation Account; or (ii) the minimum regulatory capital requirements of the Bank contained in Part 567 of the Rules and Regulations of the OTS. 20. VOTING RIGHTS OF STOCKHOLDERS Following consummation of the Conversion, voting rights with respect to the Bank shall be held and exercised exclusively by the holders of its capital stock. The holders of the voting capital stock of the Holding Company shall have the exclusive voting rights with respect to the Holding Company. 21. RESTRICTIONS ON RESALE OR SUBSEQUENT DISPOSITION A. All shares of Holding Company Common Stock purchased by Directors or Officers in the Offering shall be subject to the restriction that, except as provided in this Section or as may be approved by the OTS, no interest in such shares may be sold or otherwise disposed of for value for a period of one year following the date of purchase in the Offering. B. The restriction on disposition of Holding Company Common Stock set forth above in this Section shall not apply to the following: (1) Any exchange of such shares in connection with a merger or acquisition involving the Bank or the Holding Company, as the case may be, which has been approved by the OTS; and (2) Any disposition of such shares following the death of the person to whom such shares were initially sold under the terms of this Plan. C. With respect to all shares of Holding Company Common Stock subject to the restrictions on resale or subsequent disposition described in paragraph A above, each of the following provisions shall apply: (1) Each certificate representing shares restricted by this section shall bear a legend prominently stamped on its face giving notice of the restriction; (2) Instructions shall be issued to the stock transfer agent for the Holding Company not to recognize or effect any transfer of any certificate or record of ownership of any such shares in violation of the restriction on transfer; and (3) Any shares of capital stock of the Holding Company issued with respect to a stock dividend, stock split, or otherwise with respect to ownership of outstanding shares of 20 Holding Company Common Stock subject to the restriction on transfer hereunder shall be subject to the same restriction as is applicable to such Holding Company Common Stock. 22. REQUIREMENTS FOR STOCK PURCHASES BY DIRECTORS AND OFFICERS FOLLOWING THE CONVERSION For a period of three years following the Conversion, no Officer, Director or their Associates shall purchase, without the prior written approval of the OTS, any outstanding shares of Holding Company Common Stock except from a broker-dealer registered with the SEC. This provision shall not apply to negotiated transactions involving more than 1% of the outstanding shares of Holding Company Common Stock, the exercise of any options pursuant to a stock option plan or purchases of Holding Company Common Stock made by or held by any Tax-Qualified Employee Stock Benefit Plan or non-Tax-Qualified Employee Stock Benefit Plan of the Bank or the Holding Company (including the Employee Plans) which may be attributable to any Officer or Director. As used herein, the term "negotiated transaction" means a transaction in which the securities are offered and the terms and arrangements relating to any sale are arrived at through direct communications between the seller or any Person acting on its behalf and the purchaser or his investment representative. The term "investment representative" shall mean a professional investment advisor acting as agent for the purchaser and independent of the seller and not acting on behalf of the seller in connection with the transaction. 23. TRANSFER OF DEPOSIT ACCOUNTS Each Person holding a Deposit Account at the Bank at the time of Conversion shall retain an identical Deposit Account at the Bank following the Conversion in the same amount and subject to the same terms and conditions (except as to voting and liquidation rights). 24. REGISTRATION AND MARKETING Within the time period required by applicable laws and regulations, the Holding Company will register the securities issued in connection with the Conversion pursuant to the Securities Exchange Act of 1934 (or will be a successor issuer that succeeds to the registration of the Mid-Tier Holding Company) and will not deregister such securities for a period of at least three years thereafter, except that the maintenance of registration for three years requirement may be fulfilled by any successor to the Bank or any holding company of the Bank. In addition, the Bank or Holding Company will use its best efforts to encourage and assist a market-maker to establish and maintain a market for the Holding Company Common Stock and to list those securities on a national or regional securities exchange or the Nasdaq Stock Market. 25. TAX RULINGS OR OPINIONS Consummation of the Conversion is expressly conditioned upon prior receipt by the Mutual Holding Company, the Mid-Tier Holding Company and the Bank of either a ruling or an opinion of counsel with respect to federal tax laws, and either a ruling, an opinion of counsel, or a letter of advice from their tax advisor with respect to North Carolina tax laws, to the effect that 21 consummation of the transactions contemplated by the Conversion and this Plan will not result in a taxable reorganization under the provisions of the applicable codes or otherwise result in any adverse tax consequences to the Mutual Holding Company, the Mid-Tier Holding Company, the Holding Company or the Bank, or the Account Holders receiving subscription rights before or after the Conversion, except in each case to the extent, if any, that subscription rights are deemed to have value on the date such rights are issued. 26. STOCK BENEFIT PLANS AND EMPLOYMENT AGREEMENTS A. The Holding Company and the Bank are authorized to adopt Tax-Qualified Employee Stock Benefit Plans in connection with the Conversion, including without limitation, an ESOP. Existing, as well as any newly created, Tax-Qualified Employee Stock Benefit Plans may purchase shares of Holding Company Common Stock in the Conversion, to the extent permitted by the terms of such benefit plans and this Plan. B. As a result of the Conversion, the Holding Company shall be deemed to have ratified and approved the stock benefit plans maintained by the Bank and the Mid-Tier Holding Company and shall have agreed to issue (and reserve for issuance) Holding Company Common Stock in lieu of common stock of the Mid-Tier Holding Company pursuant to the terms of such benefit plans. Upon consummation of the Conversion, the Mid-Tier Holding Company common stock held by such benefit plans shall be converted into Holding Company Common Stock based upon the Exchange Ratio. Also upon consummation of the Conversion, (i) all rights to purchase, sell or receive Mid-Tier Holding Company common stock and all rights to elect to make payment in Mid-Tier Holding Company common stock under any agreement between the Bank or the Mid-Tier Holding Company and any Director, Officer or Employee thereof or under any plan or program of the Bank or the Mid-Tier Holding Company shall automatically, by operation of law, be converted into and shall become an identical right to purchase, sell or receive Holding Company Common Stock and an identical right to make payment in Holding Company Common Stock under any such agreement between the Bank or the Mid-Tier Holding Company and any Director, Officer or Employee thereof or under such plan or program of the Bank, and (ii) rights outstanding under any stock option plan of the Bank or the Mid-Tier Holding Company shall be assumed by the Holding Company and thereafter shall be rights only for shares of Holding Company Common Stock, with each such right being for a number of shares of Holding Company Common Stock based upon the Exchange Ratio and the number of shares of Mid-Tier Holding Company common stock that were available thereunder immediately prior to consummation of the Conversion, with the price adjusted to reflect the Exchange Ratio but with no change in any other term or condition of such right. C. The Holding Company and the Bank are authorized to enter into employment agreements with their executive officers. D. The Holding Company and the Bank are authorized to adopt stock option plans, restricted stock grant plans and other non-Tax-Qualified Employee Stock Benefit Plans, provided that such plans conform to any applicable requirements of OTS regulations. 22 27. RESTRICTIONS ON ACQUISITION OF BANK AND HOLDING COMPANY A. In accordance with OTS regulations, for a period of three years from the date of consummation of the Conversion, no Person, other than the Holding Company, shall directly or indirectly acquire or offer to acquire the beneficial ownership of more than 10% of any class of an equity security of the Bank without the prior written consent of the OTS. (1) The charter of the Bank may contain a provision stipulating that no Person, except the Holding Company, for a period of five years following the closing date of the Conversion, may directly or indirectly acquire or offer to acquire the beneficial ownership of more than 10% of any class of an equity security of the Bank, without the prior written approval of the OTS. In addition, such charter may also provide that for a period of five years following the closing date of the Conversion, shares beneficially owned in violation of the above-described charter provision shall not be entitled to vote and shall not be voted by any Person or counted as voting stock in connection with any matter submitted to stockholders for a vote. In addition, special meetings of the stockholders relating to changes in control or amendment of the charter may only be called by the Board of Directors, and shareholders shall not be permitted to cumulate their votes for the election of Directors. (2) The Certificate of Incorporation of the Holding Company will contain a provision stipulating that in no event shall any record owner of any outstanding shares of Holding Company Common Stock who beneficially owns in excess of 10% of such outstanding shares be entitled or permitted to any vote in respect to any shares held in excess of 10%. In addition, the Certificate of Incorporation and Bylaws of the Holding Company will contain provisions which provide for staggered terms of the Directors, noncumulative voting for Directors, limitations on the calling of special meetings and certain notice requirements. B. For the purposes of this section: (1) The term "Person" includes an individual, a firm, a corporation or other entity; (2) The term "offer" includes every offer to buy or acquire, solicitation of an offer to sell, tender offer for, or request or invitation for tenders of, a security or interest in a security for value; (3) The term "acquire" includes every type of acquisition, whether effected by purchase, exchange, operation of law or otherwise; and (4) The term "security" includes nontransferable subscription rights issued pursuant to a plan of conversion as well as a "security" as defined in Section 2(a)(l) of the Securities Act of 1933. 23 28. PAYMENT OF DIVIDENDS AND REPURCHASE OF STOCK A. The Holding Company shall comply with any applicable OTS regulation in the repurchase of any shares of its capital stock during the first year following consummation of the Conversion. B. The Bank shall not declare or pay a cash dividend on, or repurchase any of, its capital stock if the effect thereof would cause its regulatory capital to be reduced below (i) the amount required for the Liquidation Account or (ii) the minimum regulatory capital requirement in Section 567.2 of the Rules and Regulations of the OTS. Otherwise, the Bank may declare dividends or make capital distributions in accordance with applicable law and regulations, including 12 C.F.R. Section 563.141 or its successor. 29. CHARTER AND BYLAWS By voting to adopt this Plan, Members of the Mutual Holding Company will be voting to adopt a Certificate of Incorporation and Bylaws for the Holding Company attached as Exhibits D and E to this Plan. 30. CONSUMMATION OF CONVERSION AND EFFECTIVE DATE The Effective Date of the Conversion shall be the date upon which the Articles of Combination shall be filed with the OTS with respect to the MHC Merger, the Mid-Tier Merger and the Bank Merger. The Articles of Combination shall be filed with the OTS after all requisite regulatory, member and stockholder approvals have been obtained, all applicable waiting periods have expired, and sufficient subscriptions and orders for Subscription Shares have been received. The Closing of the sale of all shares of Holding Company Common Stock sold in the Subscription Offering, Community Offering and/or Syndicated Community Offering shall occur simultaneously on the effective date of the Closing. 31. EXPENSES OF CONVERSION The Mutual Holding Company, the Mid-Tier Holding Company, the Bank and the Holding Company may retain and pay for the services of legal, financial and other advisors to assist in connection with any or all aspects of the Conversion, including the Offering, and such parties shall use their best efforts to assure that such expenses shall be reasonable. 32. AMENDMENT OR TERMINATION OF PLAN This Plan may be substantively amended by the Board of Directors of the Mutual Holding Company at the discretion of the Board of Directors or as a result of comments from regulatory authorities at any time prior to the solicitation of proxies from Members and Mid-Tier Holding Company stockholders to vote on this Plan, and at any time thereafter by the Board of Directors of the Mutual Holding Company with the concurrence of the OTS. Any amendment to this Plan made after approval by the Members and Mid-Tier Holding Company stockholders with the approval of the OTS shall not necessitate further approval by the Members or Mid-Tier Holding Company stockholders unless otherwise required by the OTS. This Plan may be terminated by the Board of 24 Directors of the Mutual Holding Company at any time prior to the Special Meeting of Members and the Special Meeting of Stockholders to vote on this Plan, and at any time thereafter with the concurrence of the OTS. By adoption of the Plan, the Members of the Mutual Holding Company authorize the Board of Directors of the Mutual Holding Company to amend or terminate the Plan under the circumstances set forth in this Section. 33. CONDITIONS TO CONVERSION Consummation of the Conversion pursuant to this Plan is expressly conditioned upon the following: A. Prior receipt by the Mutual Holding Company, the Mid-Tier Holding Company, and the Bank of rulings of the United States Internal Revenue Service and the State of North Carolina taxing authorities, or opinions of counsel or tax advisers as described in Section 25 hereof; B. The sale of the shares of Holding Company Common Stock offered in the Conversion; and C. The completion of the Conversion within the time period specified in Section 3 of this Plan. 34. INTERPRETATION All interpretations of this Plan and application of its provisions to particular circumstances by a majority of the Board of Directors of the Mutual Holding Company shall be final, subject to the authority of the OTS. Dated: May 23, 2002. 25 EXHIBIT A AGREEMENT OF MERGER BETWEEN CITIZENS SOUTH BANKING CORPORATION CITIZENS SOUTH INTERIM SAVINGS BANK I, AND CITIZENS SOUTH BANK FORM OF AGREEMENT OF MERGER BETWEEN CITIZENS SOUTH BANKING CORPORATION, CITIZENS SOUTH INTERIM SAVINGS BANK I AND CITIZENS SOUTH BANK THIS AGREEMENT OF MERGER (this "Merger Agreement"), dated as of _____________, 2002, is made by and between Citizens South Banking Corporation, a federal corporation ("Mid-Tier Holding Company"), Citizens South Bank, a federal stock savings bank (the "Bank"), and Citizens South Interim Savings Bank I, an interim federal savings bank ("Interim I"). R E C I T A L S : 1. Mid-Tier Holding Company is a federal corporation which owns 100% of the common stock of the Bank. 2. Pursuant to the Merger Agreement, Mid-Tier Holding Company will convert to or exchange its charter for a federal interim savings bank charter and shall merge with and into the Bank with the Bank as the surviving entity (the "Mid-Tier Merger"). The Mid-Tier Holding Company stockholders shall constructively receive shares of Bank common stock in exchange for Mid-Tier Holding Company common stock that they actually or constructively hold. 3. At least two-thirds of the members of the boards of directors of the Bank, Interim I and Mid-Tier Holding Company have approved this Merger Agreement under which Mid-Tier Holding Company shall be merged with and into the Bank with the Bank as the surviving or resulting institution (the "Resulting Institution"), and authorized the execution and delivery thereof. 4. This Merger Agreement (and the transactions contemplated hereby) are being entered into to facilitate the conversion of Citizens South Holdings, MHC to stock form pursuant to that certain Plan of Conversion and Reorganization of Citizens South Holdings, MHC (the "Plan"). NOW, THEREFORE, in consideration of the premises and mutual agreements contained herein, the parties hereto have agreed as follows: 1. Merger. At and on the Effective Date (as defined below), (i) Mid-Tier Holding Company shall exchange its charter for the charter of Interim I and will merge with and into the Bank with the Bank as the Resulting Institution, and (ii) Mid-Tier Holding Company/Interim I stockholders shall constructively receive shares of Bank common stock in exchange for their Mid-Tier Holding Company/Interim I common stock. 2. Effective Date. The Mid-Tier Merger shall not be effective until and unless it is approved by the Director of the Office of Thrift Supervision (the "OTS") after approval by at least two-thirds of the outstanding common stock of Mid-Tier Holding Company and the Articles of Combination shall have been filed with the OTS with respect to the Mid-Tier Merger. Approval of the Plan by the stockholders of Mid-Tier Holding Company shall also constitute approval of this Merger Agreement. A-1 3. Name. The name of the Resulting Institution shall be Citizens South Bank. 4. Offices. The main office of the Resulting Institution shall be 245 West Main Avenue, Gastonia, North Carolina. The offices of the Bank that were in lawful operation prior to the Mid-Tier Merger shall be operated as offices of the Resulting Institution after the Mid-Tier Merger. 5. Directors and Officers. The directors and officers of the Bank immediately prior to the Effective Date shall be the directors and officers of the Resulting Institution after the Effective Date. 6. Rights and Duties of the Resulting Institution. At the Effective Date, the Mid-Tier Holding Company shall convert to Interim I, which shall be merged with and into the Bank with the Bank as the Resulting Institution. The business of the Resulting Institution shall be that of a federal savings bank as provided in its charter. All assets, rights, interests, privileges, powers, franchises and property (real, personal and mixed) of Mid-Tier Holding Company, Interim I and the Bank shall be automatically transferred to and vested in the Resulting Institution by virtue of the Mid-Tier Merger without any deed or other document of transfer. The Resulting Institution, without any order or action on the part of any court or otherwise and without any documents of assumption or assignment, shall hold and enjoy all of the properties, franchises and interests, including appointments, powers, designations, nominations and all other rights and interests as the agent or other fiduciary in the same manner and to the same extent as such rights, franchises, and interests and powers were held or enjoyed by Mid-Tier Holding Company, Interim I and the Bank. The Resulting Institution shall be responsible for all of the liabilities, restrictions and duties of every kind and description of Mid-Tier Holding Company, Interim I and the Bank immediately prior to the Mid-Tier Merger, including liabilities for all debts, obligations and contracts of Mid-Tier Holding Company, Interim I and the Bank, matured or unmatured, whether accrued, absolute, contingent or otherwise and whether or not reflected or reserved against on balance sheets, books of accounts or records of the Mid-Tier Holding Company and the Bank. The stockholders of the Bank shall possess all voting rights with respect to the shares of stock of the Bank. All rights of creditors and other obligees and all liens on property of Mid-Tier Holding Company, Interim I and the Bank shall be preserved and shall not be released or impaired. 7. Other Terms. All terms used in this Merger Agreement shall, unless defined herein, have the meanings set forth in the Plan. The Plan is incorporated herein by this reference and made a part hereof to the extent necessary or appropriate to effect and consummate the terms of this Merger Agreement and the Conversion. A-2 IN WITNESS WHEREOF, Mid-Tier Holding Company, Interim I and the Bank have caused this Merger Agreement to be executed as of the date first above written.
CITIZENS SOUTH BANKING CORPORATION ATTEST: By: By: -------------------------------------------------- -------------------------------------------------- Paul L. Teem, Jr., Secretary Kim S. Price, President and Chief Executive Officer CITIZENS SOUTH BANK ATTEST: By: By: -------------------------------------------------- -------------------------------------------------- Paul L. Teem, Jr., Secretary Kim S. Price, President and Chief Executive Officer CITIZENS SOUTH INTERIM SAVINGS BANK I ATTEST: By: By: -------------------------------------------------- -------------------------------------------------- Paul L. Teem, Jr., Secretary Kim S. Price, President
A-3 EXHIBIT B AGREEMENT OF MERGER BETWEEN CITIZENS SOUTH HOLDINGS, MHC CITIZENS SOUTH INTERIM SAVINGS BANK II AND CITIZENS SOUTH BANK FORM OF AGREEMENT OF MERGER BETWEEN CITIZENS SOUTH HOLDINGS, MHC CITIZENS SOUTH INTERIM SAVINGS BANK II AND CITIZENS SOUTH BANK THIS AGREEMENT OF MERGER (this "Merger Agreement"), dated as of ___________, 2002, is made by and between Citizens South Holdings, MHC, a federal mutual holding company (the "Mutual Holding Company"), Citizens South Bank (the "Bank"), and Citizens South Interim Savings Bank II, an interim federal savings bank ("Interim II"). R E C I T A L S: 1. The Mutual Holding Company is a federal mutual holding company with no authorized shares of capital stock. 2. After the merger of Citizens South Banking Corporation and Citizens South Interim Savings Bank I into the Bank, the majority of the shares of common stock of the Bank will be owned by the Mutual Holding Company, and the remainder of the shares of common stock of the Bank will be constructively owned by the Bank's employees, directors and the public (the "Minority Stockholders"). 3. Pursuant to this Merger Agreement, the Mutual Holding Company will convert to or exchange its charter for the federal interim savings bank charter of Interim II, and Interim II shall merge with and into the Bank with the Bank as the surviving entity (the "MHC Merger"). Each Eligible Account Holder and Supplemental Eligible Account Holder, as defined in the Plan of Conversion and Reorganization of Citizens South Holdings, MHC (the "Plan"), will receive an interest in a liquidation account ("Liquidation Account") of the Bank in exchange for such person's interest in the Mutual Holding Company. 4. At least two-thirds of the members of the boards of directors of the Bank and the Mutual Holding Company have approved this Merger Agreement and the MHC Merger (as described below) and authorized the execution and delivery thereof. 5. This Merger Agreement (and the transactions contemplated hereby) is being entered into to facilitate the conversion of the Mutual Holding Company to stock form pursuant to the Plan. NOW, THEREFORE, in consideration of the premises and mutual agreements contained herein, the parties hereto have agreed as follows: 1. Merger. At and on the Effective Date (as defined below), (i) the Mutual Holding Company shall convert to or exchange its charter for the charter of Interim II, and Interim II will merge with and into the Bank (the "MHC Merger") with the Bank as the surviving or resulting institution (the "Resulting Institution"), (ii) each share of Bank common stock owned by the Mutual Holding Company shall be canceled, and (iii) each Eligible Account Holder and Supplemental B-1 Eligible Account Holder shall automatically receive an interest in the Liquidation Account which shall be established in the Bank, in exchange for such person's interest in the Mutual Holding Company as set forth in the Plan. 2. Effective Date. The MHC Merger shall not be effective until and unless it is approved by the Director of the Office of Thrift Supervision (the "OTS") after approval by (i) two-thirds of the outstanding common stock of the Bank, and (ii) a majority of the members of the Mutual Holding Company, and the Articles of Combination shall have been filed with the OTS with respect to the MHC Merger. Approval of the Plan by the members of the Mutual Holding Company shall also constitute approval of this Merger Agreement. 3. Name. The name of the Resulting Institution shall be Citizens South Bank. 4. Offices. The main offices of the Resulting Institution shall be 245 West Main Avenue, Gastonia, North Carolina. The offices of the Bank that were in lawful operation prior to the MHC Merger shall continue to be operated as the offices of the Resulting Institution after the MHC Merger. 5. Directors and Officers. The directors and officers of the Bank immediately prior to the Effective Date shall be the directors and officers of the Resulting Institution after the Effective Date. 6. Rights and Duties of the Resulting Institution. At the Effective Date, the Mutual Holding Company shall convert to Interim II, which shall merge with and into the Bank with the Bank as the Resulting Institution. The business of the Resulting Institution shall be that of a federal savings bank as provided in its Charter. All assets, rights, interests, privileges, powers, franchises and property (real, personal and mixed) of the Mutual Holding Company, Interim II and the Bank shall be automatically transferred to and vested in the Resulting Institution by virtue of such merger without any deed or other document of transfer. The Resulting Institution, without any order or action on the part of any court or otherwise and without any documents of assumption or assignment, shall hold and enjoy all of the properties, franchises and interests, including appointments, powers, designations, nominations and all other rights and interests as the agent or other fiduciary in the same manner and to the same extent as such rights, franchises, and interests and powers were held or enjoyed by the Mutual Holding Company, Interim II and the Bank. The Resulting Institution shall be responsible for all of the liabilities, restrictions and duties of every kind and description of both the Mutual Holding Company, Interim II and the Bank immediately prior to the MHC Merger, including liabilities, debts, obligations and contracts of the Mutual Holding Company, Interim II and the Bank, matured or unmatured, whether accrued, absolute, contingent or otherwise and whether or not reflected or reserved against on balance sheets, books of accounts or records of the Mutual Holding Company, Interim II and the Bank. The stockholders of the Bank shall possess all voting rights with respect to the shares of stock of the Bank. All rights of creditors and other obligees and all liens on property of either the Mutual Holding Company, Interim II or the Bank shall be preserved and shall not be released or impaired. 7. Other Terms. All terms used in this Merger Agreement shall, unless defined herein, have the meanings set forth in the Plan. The Plan is incorporated herein by this reference and made a B-2 part hereof to the extent necessary or appropriate to effect and consummate the terms of this Merger Agreement and the Conversion. IN WITNESS WHEREOF, the Mutual Holding Company, Interim II and the Bank have caused this Merger Agreement to be executed as of the date first above written.
CITIZENS SOUTH HOLDINGS, MHC ATTEST: By: By: -------------------------------------------------- -------------------------------------------------- Paul L. Teem, Jr., Secretary Kim S. Price, President and Chief Executive Officer CITIZENS SOUTH BANK ATTEST: By: By: -------------------------------------------------- -------------------------------------------------- Paul L. Teem, Jr., Secretary Kim S. Price, President and Chief Executive Officer CITIZENS SOUTH INTERIM SAVINGS BANK II ATTEST: By: By: -------------------------------------------------- -------------------------------------------------- Paul L. Teem, Jr., Secretary Kim S. Price, President
B-3 EXHIBIT C AGREEMENT OF MERGER BETWEEN CITIZENS SOUTH BANK AND CITIZENS SOUTH INTERIM SAVINGS BANK FORM OF AGREEMENT OF MERGER BETWEEN CITIZENS SOUTH BANK AND CITIZENS SOUTH INTERIM SAVINGS BANK THIS AGREEMENT OF MERGER (this "Merger Agreement"), dated as of __________________, 2002, is made by and between Citizens South Bank, a federal savings bank (the "Bank"), and Citizens South Interim Savings Bank, an interim federal savings bank ("Interim"). R E C I T A L S : 1. The Bank is a federal savings bank that immediately prior to the transactions contemplated by this Merger Agreement and the Plan of Conversion and Reorganization of Citizens South Holdings, MHC (the "Plan") was a wholly-owned subsidiary of Citizens South Banking Corporation (the "Mid-Tier Holding Company"), a Federal corporation. Mid-Tier Holding Company was a majority-owned subsidiary of Citizens South Holdings, MHC (the "Mutual Holding Company"). 2. Pursuant to the Plan and its related merger agreements, (i) Mid-Tier Holding Company has converted to Citizens South Interim Savings Bank I, an interim federal savings bank ("Interim I") and Interim I has merged with and into the Bank (the "Mid-Tier Merger") with the Bank as the resulting entity, (ii) Mid-Tier Holding Company stockholders have constructively received shares of Bank common stock in exchange for their Mid-Tier Holding Company common stock, (iii) the Mutual Holding Company has converted to, or exchanged its charter for, a federal interim savings bank ("Interim II") which has merged with and into the Bank with the Bank as the resulting entity, and (iv) each Eligible Account Holder and Supplemental Eligible Account Holder (as defined in the Plan) has received an interest in a Liquidation Account of the Bank in exchange for such person's interest in the Mutual Holding Company. 3. Pursuant to the Plan, following the completion of each of the steps outlined in paragraph 2 above, the Bank has organized Citizens South Banking Corporation, a Delaware corporation (the "Holding Company"), to become the holding company of the Bank, and the Holding Company has organized Interim for the purpose of facilitating the conversion of the Mutual Holding Company to stock form (the "Conversion") pursuant to the Plan. 4. At least two-thirds of the members of the boards of directors of the Bank and Interim have approved this Merger Agreement under which Interim shall be merged with and into the Bank with the Bank as the surviving or resulting institution, and authorized the execution and delivery thereof. 5. This Merger Agreement (and the transactions contemplated hereby) is being entered into to facilitate the conversion of the Mutual Holding Company to stock form pursuant to the Plan. NOW, THEREFORE, in consideration of the premises and mutual agreements contained herein, the parties hereto have agreed as follows: C-1 1. Merger. At and on the Effective Date (as defined below) and immediately following the Mid-Tier Merger and the MHC Merger (i) Interim will merge with and into the Bank (the "Bank Merger") with the Bank as the surviving or resulting institution ("Resulting Institution"), whereby (ii) all constructive shareholders of the Bank (i.e., Minority Stockholders immediately prior to the Conversion) will exchange the shares of Bank common stock that they constructively received in the Mid-Tier Merger for Holding Company Common Stock. 2. Stock Offering. Immediately after the Bank Merger, the Holding Company shall sell shares of its common stock in a subscription and community offering as described in the Plan. 3. Effective Date. The Bank Merger shall not be effective until and unless it is approved by the Director of the Office of Thrift Supervision (the "OTS") after approval by at least two-thirds of the outstanding common stock of the Bank and Interim, and the Articles of Combination shall have been filed with the OTS with respect to the Bank Merger. 4. Name. The name of the Resulting Institution shall be Citizens South Bank. 5. Offices. The main offices of the Resulting Institution shall be 245 West Main Avenue, Gastonia, North Carolina. The offices of the Bank that were in lawful operation prior to the Bank Merger shall be operated as offices of the Resulting Institution after the Bank Merger. 6. Directors and Officers. The directors and officers of the Bank immediately prior to the Effective Date shall be the directors and officers of the Resulting Institution after the Effective Date. 7. Rights and Duties of the Resulting Institution. At the Effective Date, Interim shall be merged with and into the Bank with the Bank as the Resulting Institution. The business of the Resulting Institution shall be that of a federal savings bank as provided in its charter. All assets, rights, interests, privileges, powers, franchises and property (real, personal and mixed) of Interim and the Bank shall be automatically transferred to and vested in the Resulting Institution by virtue of the Bank Merger without any deed or other document of transfer. The Resulting Institution, without any order or action on the part of any court or otherwise and without any documents of assumption or assignment, shall hold and enjoy all of the properties, franchises and interests, including appointments, powers, designations, nominations and all other rights and interests as the agent or other fiduciary in the same manner and to the same extent as such rights, franchises, and interests and powers were held or enjoyed by Interim and the Bank. The Resulting Institution shall be responsible for all of the liabilities, restrictions and duties of every kind and description of Interim and the Bank immediately prior to the Bank Merger, including liabilities for all debts, obligations and contracts of Bank and Interim, matured or unmatured, whether accrued, absolute, contingent or otherwise and whether or not reflected or reserved against on balance sheets, books of accounts or records of Interim and the Bank. The stockholders of the Resulting Institution shall possess all voting rights with respect to the shares of stock of the Bank. All rights of creditors and other obligees and all liens on property of Interim and the Bank shall be preserved and shall not be released or impaired. C-2 8. Other Terms. All terms used in this Merger Agreement shall, unless defined herein, have the meanings set forth in the Plan. The Plan is incorporated herein by this reference and made a part hereof to the extent necessary or appropriate to effect and consummate the terms of the Merger Agreement and the Conversion. IN WITNESS WHEREOF, the Bank and Interim have caused this Merger Agreement to be executed as of the date first above written.
CITIZENS SOUTH BANK ATTEST: By: By: -------------------------------------------------- -------------------------------------------------- Paul L. Teem, Jr., Secretary Kim S. Price, President and Chief Executive Officer CITIZENS SOUTH INTERIM SAVINGS BANK ATTEST: By: By: -------------------------------------------------- -------------------------------------------------- Paul L. Teem, Jr., Secretary Kim S. Price, President
C-3 EXHIBIT D CERTIFICATE OF INCORPORATION OF THE HOLDING COMPANY CERTIFICATE OF INCORPORATION OF CITIZENS SOUTH BANKING CORPORATION FIRST: The name of the Corporation is Citizens South Banking Corporation (hereinafter referred to as the "Corporation"). SECOND: The address of the registered office of the Corporation in the State of Delaware is Corporation Trust Center, 1209 Orange Street, in the City of Wilmington, County of New Castle. The name of the registered agent at that address is The Corporation Trust Company. THIRD: The purpose of the Corporation is to engage in any lawful act or activity for which a corporation may be organized under the General Corporation Law of Delaware. FOURTH: A. The total number of shares of all classes of stock which the Corporation shall have authority to issue is twenty-one million (21,000,000) consisting of: 1. one million (1,000,000) shares of Preferred Stock, par value one cent ($.01) per share (the "Preferred Stock"); and 2. twenty million (20,000,000) shares of Common Stock, par value one cent ($.01) per share (the "Common Stock"). B. The Board of Directors is authorized, subject to any limitations prescribed by law, to provide for the issuance of the shares of Preferred Stock in series, and by filing a certificate pursuant to the applicable law of the State of Delaware (such certificate being hereinafter referred to as a "Preferred Stock Designation"), to establish from time to time the number of shares to be included in each such series, and to fix the designation, powers, preferences, and rights of the shares of each such series and any qualifications, limitations or restrictions thereof. The number of authorized shares of Preferred Stock may be increased or decreased (but not below the number of shares thereof then outstanding) by the affirmative vote of the holders of a majority of the Common Stock, without a vote of the holders of the Preferred Stock, or of any series thereof, unless a vote of any such holders is required pursuant to the terms of any Preferred Stock Designation. C. 1. Notwithstanding any other provision of this Certificate of Incorporation, in no event shall any record owner of any outstanding Common Stock which is beneficially owned, directly or indirectly, by a person who, as of any record date for the determination of stockholders entitled to vote on any matter, beneficially owns in excess of 10% of the then-outstanding shares of Common Stock (the "Limit"), be entitled, or permitted to any vote in respect of the shares held in excess of the Limit. The number of votes which may be cast by any record owner by virtue of the provisions hereof in respect of Common Stock beneficially owned by such person owning shares in excess of the Limit shall be a number equal to the total number of votes which a single record owner of all Common Stock owned by such person would be entitled to cast subject to this Section C of this Article FOURTH, multiplied by a fraction, the numerator of which is the number of shares of such D-1 class or series which are both beneficially owned by such person and owned of record by such record owner and the denominator of which is the total number of shares of Common Stock beneficially owned by such person owning shares in excess of the Limit. 2. The following definitions shall apply to this Section C of this Article FOURTH: (a) "Affiliate" shall have the meaning ascribed to it in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as in effect on the date of filing of this Certificate of Incorporation. (b) "Beneficial ownership" shall be determined pursuant to Rule 13d-3 of the General Rules and Regulations under the Securities Exchange Act of 1934 (or any successor rule or statutory provision), or, if said Rule 13d-3 shall be rescinded and there shall be no successor rule or statutory provision thereto, pursuant to said Rule 13d-3 as in effect on the date of filing of this Certificate of Incorporation; provided, however, that a person shall, in any event, also be deemed the "beneficial owner" of any Common Stock: (1) which such person or any of its affiliates beneficially owns, directly or indirectly; or (2) which such person or any of its affiliates has (i) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding (but shall not be deemed to be the beneficial owner of any voting shares solely by reason of an agreement, contract, or other arrangement with this Corporation to effect any transaction which is described in any one or more clauses of Section A of Article EIGHTH) or upon the exercise of conversion rights, exchange rights, warrants, or options or otherwise, or (ii) sole or shared voting or investment power with respect thereto pursuant to any agreement, arrangement, understanding, relationship or otherwise (but shall not be deemed to be the beneficial owner of any voting shares solely by reason of a revocable proxy granted for a particular meeting of stockholders, pursuant to a public solicitation of proxies for such meeting, with respect to shares of which neither such person nor any such affiliate is otherwise deemed the beneficial owner); or (3) which are beneficially owned, directly or indirectly, by any other person with which such first mentioned person or any of its affiliates acts as a partnership, limited partnership, syndicate or other group pursuant to any agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of any shares of capital stock of this Corporation; D-2 and provided further, however, that (1) no Director or Officer of this Corporation (or any affiliate of any such Director or Officer) shall, solely by reason of any or all of such Directors or Officers acting in their capacities as such, be deemed, for any purposes hereof, to beneficially own any Common Stock beneficially owned by another such Director or Officer (or any affiliate thereof), and (2) neither any employee stock ownership plan or similar plan of this Corporation or any subsidiary of this Corporation, nor any trustee with respect thereto or any affiliate of such trustee (solely by reason of such capacity of such trustee), shall be deemed, for any purposes hereof, to beneficially own any Common Stock held under any such plan. For purposes of computing the percentage beneficial ownership of Common Stock of a person the outstanding Common Stock shall include shares deemed owned by such person through application of this subsection but shall not include any other Common Stock which may be issuable by this Corporation pursuant to any agreement, or upon exercise of conversion rights, warrants or options, or otherwise. For all other purposes, the outstanding Common Stock shall include only Common Stock then outstanding and shall not include any Common Stock which may be issuable by this Corporation pursuant to any agreement, or upon the exercise of conversion rights, warrants or options, or otherwise. (c) A "person" shall mean any individual, firm, corporation, or other entity. 3. The Board of Directors shall have the power to construe and apply the provisions of this section and to make all determinations necessary or desirable to implement such provisions, including but not limited to matters with respect to (i) the number of shares of Common Stock beneficially owned by any person, (ii) whether a person is an affiliate of another, (iii) whether a person has an agreement, arrangement, or understanding with another as to the matters referred to in the definition of beneficial ownership, (iv) the application of any other definition or operative provision of this section to the given facts, or (v) any other matter relating to the applicability or effect of this section. 4. The Board of Directors shall have the right to demand that any person who is reasonably believed to beneficially own Common Stock in excess of the Limit (or holds of record Common Stock beneficially owned by any person in excess of the Limit) supply the Corporation with complete information as to (i) the record owner(s) of all shares beneficially owned by such person who is reasonably believed to own shares in excess of the Limit, and (ii) any other factual matter relating to the applicability or effect of this section as may reasonably be requested of such person. 5. Except as otherwise provided by law or expressly provided in this section, the presence, in person or by proxy, of holders of a majority of the shares of capital stock of the Corporation entitled to vote at the meeting (after giving effect, if required, to the provisions of this section) shall constitute a quorum at all meetings of the stockholders (unless or except to the extent that the presence of a larger number may be required by law), and every reference in this Certificate of Incorporation to a majority or other proportion of capital stock (or the holders thereof) for D-3 purposes of determining any quorum requirement or any requirement for stockholder consent or approval shall be deemed to refer to such majority or other proportion of the votes (or the holders thereof) then entitled to be cast in respect of such capital stock. 6. Any constructions, applications, or determinations made by the Board of Directors pursuant to this section in good faith and on the basis of such information and assistance as was then reasonably available for such purpose shall be conclusive and binding upon the Corporation and its stockholders. 7. In the event any provision (or portion thereof) of this section shall be found to be invalid, prohibited or unenforceable for any reason, the remaining provisions (or portions thereof) of this section shall remain in full force and effect, and shall be construed as if such invalid, prohibited or unenforceable provision had been stricken herefrom or otherwise rendered inapplicable, it being the intent of this Corporation and its stockholders that such remaining provision (or portion thereof) of this section remain, to the fullest extent permitted by law, applicable and enforceable as to all stockholders, including stockholders owning an amount of stock over the Limit, notwithstanding any such finding. FIFTH: The following provisions are inserted for the management of the business and the conduct of the affairs of the Corporation, and for further definition, limitation and regulation of the powers of the Corporation and of its Directors and stockholders: A. The business and affairs of the Corporation shall be managed by or under the direction of the Board of Directors. In addition to the powers and authority expressly conferred upon them by statute or by this Certificate of Incorporation or the Bylaws of the Corporation, the Directors are hereby empowered to exercise all such powers and do all such acts and things as may be exercised or done by the Corporation. B. The Directors of the Corporation need not be elected by written ballot unless the Bylaws so provide. Stockholders shall not be permitted to cumulate their votes for the election of Directors. C. Any action required or permitted to be taken by the stockholders of the Corporation must be effected at a duly called annual or special meeting of stockholders of the Corporation and may not be effected by any consent in writing by such stockholders. D. Special meetings of stockholders of the Corporation may be called only by the Board of Directors pursuant to a resolution adopted by a majority of the total number of authorized directorships (whether or not there exist any vacancies in previously authorized directorships at the time any such resolution is presented to the Board for adoption) (the "Whole Board") or as otherwise provided in the Bylaws. SIXTH: A. The number of Directors shall be fixed from time to time exclusively by the Board of Directors pursuant to a resolution adopted by a majority of the Whole Board. The Directors shall be divided into three classes, with the term of office of the first class to expire at the first annual meeting of stockholders, the term of office of the second class to expire at the annual D-4 meeting of stockholders one year thereafter and the term of office of the third class to expire at the annual meeting of stockholders two years thereafter. At each annual meeting of stockholders following such initial classification and election, Directors elected to succeed those Directors whose terms expire shall be elected for a term of office to expire at the third succeeding annual meeting of stockholders after their election. B. Subject to the rights of the holders of any series of Preferred Stock then outstanding, newly created directorships resulting from any increase in the authorized number of Directors or any vacancies in the Board of Directors resulting from death, resignation, retirement, disqualification, removal from office or other cause may be filled only by a majority vote of the Directors then in office, though less than a quorum, and Directors so chosen shall hold office for a term expiring at the annual meeting of stockholders at which the term of office of the class to which they have been chosen expires. No decrease in the number of Directors constituting the Board of Directors shall shorten the term of any incumbent Director. C. Advance notice of stockholder nominations for the election of Directors and of business to be brought by stockholders before any meeting of the stockholders of the Corporation shall be given in the manner provided in the Bylaws of the Corporation. D. Subject to the rights of the holders of any series of Preferred Stock then outstanding, any Director, or the entire Board of Directors, may be removed from office at any time, but only for cause and only by the affirmative vote of the holders of at least 80 percent of the voting power of all of the then-outstanding shares of capital stock of the Corporation entitled to vote generally in the election of Directors (after giving effect to the provisions of Article FOURTH of this Certificate of Incorporation ("Article FOURTH")), voting together as a single class. SEVENTH: The Board of Directors is expressly empowered to adopt, amend or repeal the Bylaws of the Corporation. Any adoption, amendment or repeal of the Bylaws of the Corporation by the Board of Directors shall require the approval of two-thirds of the Whole Board. The stockholders shall also have power to adopt, amend or repeal the Bylaws of the Corporation; provided, however, that, in addition to any vote of the holders of any class or series of stock of the Corporation required by law or by this Certificate of Incorporation, the affirmative vote of the holders of at least 80 percent of the voting power of all of the then-outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of Directors (after giving effect to the provisions of Article FOURTH), voting together as a single class, shall be required to adopt, amend or repeal any provisions of the Bylaws of the Corporation. EIGHTH: A. In addition to any affirmative vote required by law or this Certificate of Incorporation, and except as otherwise expressly provided in this section: 1. any merger or consolidation of the Corporation or any Subsidiary (as hereinafter defined) with (i) any Interested Stockholder (as hereinafter defined) or (ii) any other D-5 corporation (whether or not itself an Interested Stockholder) which is, or after such merger or consolidation would be, an Affiliate (as hereinafter defined) of an Interested Stockholder; or 2. any sale, lease, exchange, mortgage, pledge, transfer or other disposition (in one transaction or a series of transactions) to or with any Interested Stockholder, or any Affiliate of any Interested Stockholder, of any assets of the Corporation or any Subsidiary having an aggregate Fair Market Value (as hereinafter defined) equaling or exceeding 25% or more of the combined assets of the Corporation and its Subsidiaries; or 3. the issuance or transfer by the Corporation or any Subsidiary (in one transaction or a series of transactions) of any securities of the Corporation or any Subsidiary to any Interested Stockholder or any Affiliate of any Interested Stockholder in exchange for cash, securities or other property (or a combination thereof) having an aggregate Fair Market Value (as hereinafter defined) equaling or exceeding 25% of the combined Fair Market Value of the then-outstanding common stock of the Corporation and its Subsidiaries, except pursuant to an employee benefit plan of the Corporation or any Subsidiary thereof; or 4. the adoption of any plan or proposal for the liquidation or dissolution of the Corporation proposed by or on behalf of an Interested Stockholder or any Affiliate of an Interested Stockholder; or 5. any reclassification of securities (including any reverse stock split), or recapitalization of the Corporation, or any merger or consolidation of the Corporation with any of its Subsidiaries or any other transaction (whether or not with or into or otherwise involving an Interested Stockholder) which has the effect, directly or indirectly, of increasing the proportional share of the outstanding shares of any class of equity or convertible securities of the Corporation or any Subsidiary which is directly or indirectly owned by an Interested Stockholder or any Affiliate of an Interested Stockholder; shall require the affirmative vote of the holders of at least 80% of the voting power of the then-outstanding shares of stock of the Corporation entitled to vote in the election of Directors (the "Voting Stock") (after giving effect to the provision of Article FOURTH), voting together as a single class. Such affirmative vote shall be required notwithstanding the fact that no vote may be required, or that a lesser percentage may be specified, by law or by any other provisions of this Certificate of Incorporation or any Preferred Stock Designation or in any agreement with any national securities exchange or otherwise. The term "Business Combination" as used in this Article EIGHTH shall mean any transaction which is referred to in any one or more of paragraphs 1 through 5 of Section A of this Article EIGHTH. B. The provisions of Section A of this Article EIGHTH shall not be applicable to any particular Business Combination, and such Business Combination shall require only the affirmative vote of the majority of the outstanding shares of capital stock entitled to vote, or such vote as is required by law or by this Certificate of Incorporation, if, in the case of any Business Combination that does not involve any cash or other consideration being received by the stockholders of the D-6 Corporation solely in their capacity as stockholders of the Corporation, the condition specified in the following paragraph 1 is met or, in the case of any other Business Combination, all of the conditions specified in either of the following paragraphs 1 or 2 are met: 1. The Business Combination shall have been approved by two-thirds of the Disinterested Directors (as hereinafter defined). 2. All of the following conditions shall have been met: (a) The aggregate amount of the cash and the Fair Market Value as of the date of the consummation of the Business Combination of consideration other than cash to be received per share by the holders of Common Stock in such Business Combination shall at least be equal to the higher of the following: (1) (if applicable) the Highest Per Share Price (as hereinafter defined), including any brokerage commissions, transfer taxes and soliciting dealers' fees, paid by the Interested Stockholder or any of its Affiliates for any shares of Common Stock acquired by it (i) within the two-year period immediately prior to the first public announcement of the proposal of the Business Combination (the "Announcement Date"), or (ii) in the transaction in which it became an Interested Stockholder, whichever is higher. (2) the Fair Market Value per share of Common Stock on the Announcement Date or on the date on which the Interested Stockholder became an Interested Stockholder (such latter date is referred to in this Article EIGHTH as the "Determination Date"), whichever is higher. (b) The aggregate amount of the cash and the Fair Market Value as of the date of the consummation of the Business Combination of consideration other than cash to be received per share by holders of shares of any class of outstanding Voting Stock other than Common Stock shall be at least equal to the highest of the following (it being intended that the requirements of this subparagraph (b) shall be required to be met with respect to every such class of outstanding Voting Stock, whether or not the Interested Stockholder has previously acquired any shares of a particular class of Voting Stock): (1) (if applicable) the Highest Per Share Price (as hereinafter defined), including any brokerage commissions, transfer taxes and soliciting dealers' fees, paid by the Interested Stockholder for any shares of such class of Voting Stock acquired by it (i) within the two-year period immediately prior to the Announcement Date, or (ii) in the transaction in which it became an Interested Stockholder, whichever is higher; (2) (if applicable) the highest preferential amount per share to which the holders of shares of such class of Voting Stock are entitled in the event of D-7 any voluntary or involuntary liquidation, dissolution or winding up of the Corporation; and (3) the Fair Market Value per share of such class of Voting Stock on the Announcement Date or on the Determination Date, whichever is higher. (c) The consideration to be received by holders of a particular class of outstanding Voting Stock (including Common Stock) shall be in cash or in the same form as the Interested Stockholder has paid for shares of such class of Voting Stock. If the Interested Stockholder has previously paid for shares of any class of Voting Stock with varying forms of consideration, the form of consideration to be received per share by holders of shares of such class of Voting Stock shall be either cash or the form used to acquire the largest number of shares of such class of Voting Stock previously acquired by the Interested Stockholder. The price determined in accordance with subparagraph B.2 of this Article EIGHTH shall be subject to appropriate adjustment in the event of any stock dividend, stock split, combination of shares or similar event. (d) After such Interested Stockholder has become an Interested Stockholder and prior to the consummation of such Business Combination: (1) except as approved by a majority of the Disinterested Directors, there shall have been no failure to declare and pay at the regular date therefor any full quarterly dividends (whether or not cumulative) on any outstanding stock having preference over the Common Stock as to dividends or liquidation; (2) there shall have been (i) no reduction in the annual rate of dividends paid on the Common Stock (except as necessary to reflect any subdivision of the Common Stock), except as approved by a majority of the Disinterested Directors, and (ii) an increase in such annual rate of dividends as necessary to reflect any reclassification (including any reverse stock split), recapitalization, reorganization or any similar transaction which has the effect of reducing the number of outstanding shares of the Common Stock, unless the failure to so increase such annual rate is approved by a majority of the Disinterested Directors; and (3) neither such Interested Stockholder or any of its Affiliates shall have become the beneficial owner of any additional shares of Voting Stock except as part of the transaction which results in such Interested Stockholder becoming an Interested Stockholder. (e) After such Interested Stockholder has become an Interested Stockholder, such Interested Stockholder shall not have received the benefit, directly or indirectly (except proportionately as a stockholder), of any loans, advances, guarantees, pledges or other financial assistance or any tax credits or other tax advantages provided by the Corporation, whether in anticipation of or in connection with such Business Combination or otherwise. D-8 (f) A proxy or information statement describing the proposed Business Combination and complying with the requirements of the Securities Exchange Act of 1934 and the rules and regulations thereunder (or any subsequent provisions replacing such Act, rules or regulations) shall be mailed to stockholders of the Corporation at least 30 days prior to the consummation of such Business Combination (whether or not such proxy or information statement is required to be mailed pursuant to such Act or subsequent provisions). C. For the purposes of this Article EIGHTH: 1. A "Person" shall include an individual, a group acting in concert, a corporation, a partnership, an association, a joint venture, a pool, a joint stock company, a trust, an unincorporated organization or similar company, a syndicate or any other group formed for the purpose of acquiring, holding or disposing of securities. 2. "Interested Stockholder" shall mean any person (other than the Corporation or any holding company or Subsidiary thereof) who or which: (a) is the beneficial owner, directly or indirectly, of more than 10% of the voting power of the outstanding Voting Stock; or (b) is an Affiliate of the Corporation and at any time within the two-year period immediately prior to the date in question was the beneficial owner, directly or indirectly, of 10% or more of the voting power of the then-outstanding Voting Stock; or (c) is an assignee of or has otherwise succeeded to any shares of Voting Stock which were at any time within the two-year period immediately prior to the date in question beneficially owned by an Interested Stockholder, if such assignment or succession shall have occurred in the course of a transaction or series of transactions not involving a public offering within the meaning of the Securities Act of 1933. 3. For purposes of this Article EIGHTH, "beneficial ownership" shall be determined in the manner provided in Section C of Article FOURTH hereof. 4. "Affiliate" and "Associate" shall have the respective meanings ascribed to such terms in Rule 12b-2 of the General Rules and Regulations under the Securities Exchange Act of 1934, as in effect on the date of filing of this Certificate of Incorporation. 5. "Subsidiary" means any corporation of which a majority of any class of equity security is owned, directly or indirectly, by the Corporation; provided, however, that for the purposes of the definition of Interested Stockholder set forth in paragraph 2 of this section, the term "Subsidiary" shall mean only a corporation of which a majority of each class of equity security is owned, directly or indirectly, by the Corporation. D-9 6. "Disinterested Director" means any member of the Board of Directors who is unaffiliated with the Interested Stockholder and was a member of the Board of Directors prior to the time that the Interested Stockholder became an Interested Stockholder, and any Director who is thereafter chosen to fill any vacancy of the Board of Directors or who is elected and who, in either event, is unaffiliated with the Interested Stockholder and in connection with his or her initial assumption of office is recommended for appointment or election by a majority of Disinterested Directors then on the Board of Directors. 7. "Fair Market Value" means: (a) in the case of stock, the highest closing sales price of the stock during the 30-day period immediately preceding the date in question of a share of such stock on the National Association of Securities Dealers Automated Quotation System or any system then in use, or, if such stock is admitted to trading on a principal United States securities exchange registered under the Securities Exchange Act of 1934, Fair Market Value shall be the highest sales price reported during the 30-day period preceding the date in question, or, if no such quotations are available, the Fair Market Value on the date in question of a share of such stock as determined by the Board of Directors in good faith, in each case with respect to any class of stock, appropriately adjusted for any dividend or distribution in shares of such stock or any stock split or reclassification of outstanding shares of such stock into a greater number of shares of such stock or any combination or reclassification of outstanding shares of such stock into a smaller number of shares of such stock, and (b) in the case of property other than cash or stock, the Fair Market Value of such property on the date in question as determined by the Board of Directors in good faith. 8. Reference to "Highest Per Share Price" shall in each case with respect to any class of stock reflect an appropriate adjustment for any dividend or distribution in shares of such stock or any stock split or reclassification of outstanding shares of such stock into a greater number of shares of such stock or any combination or reclassification of outstanding shares of such stock into a smaller number of shares of such stock. 9. In the event of any Business Combination in which the Corporation survives, the phrase "consideration other than cash to be received" as used in subparagraphs (a) and (b) of paragraph 2 of Section B of this Article EIGHTH shall include the shares of Common Stock and/or the shares of any other class of outstanding Voting Stock retained by the holders of such shares. D. A majority of the Directors of the Corporation shall have the power and duty to determine for the purposes of this Article EIGHTH, on the basis of information known to them after reasonable inquiry (a) whether a person is an Interested Stockholder; (b) the number of shares of Voting Stock beneficially owned by any person; (c) whether a person is an Affiliate or Associate of another; and (d) whether the assets which are the subject of any Business Combination have, or the consideration to be received for the issuance or transfer of securities by the Corporation or any Subsidiary in any Business Combination has, an aggregate Fair Market Value equaling or exceeding 25% of the combined Fair Market Value of the common stock of the Corporation and its Subsidiaries. A majority of the Directors shall have the further power to interpret all of the terms and provisions of this Article EIGHTH. D-10 E. Nothing contained in this Article EIGHTH shall be construed to relieve any Interested Stockholder from any fiduciary obligation imposed by law. F. Notwithstanding any other provisions of this Certificate of Incorporation or any provision of law which might otherwise permit a lesser vote or no vote, but in addition to any affirmative vote of the holders of any particular class or series of the Voting Stock required by law, this Certificate of Incorporation or any Preferred Stock Designation, the affirmative vote of the holders of at least 80 percent of the voting power of all of the then-outstanding shares of the Voting Stock, voting together as a single class, shall be required to alter, amend or repeal this Article EIGHTH. NINTH: The Board of Directors of the Corporation, when evaluating any offer of another Person (as defined in Article EIGHTH hereof) to (A) make a tender or exchange offer for any equity security of the Corporation, (B) merge or consolidate the Corporation with another corporation or entity or (C) purchase or otherwise acquire all or substantially all of the properties and assets of the Corporation, may, in connection with the exercise of its judgment in determining what is in the best interest of the Corporation and its stockholders, give due consideration to all relevant factors, including, without limitation, the social and economic effect of acceptance of such offer on: the Corporation's present and future customers and employees and those of its Subsidiaries (as defined in Article EIGHTH hereof); the communities in which the Corporation and its Subsidiaries operate or are located; the ability of the Corporation to fulfill its corporate objectives as a savings or bank holding company; and the ability of its subsidiary bank to fulfill its corporate objectives under applicable statutes and regulations. TENTH: A. Each person who was or is made a party or is threatened to be made a party to or is otherwise involved in any action, suit or proceeding, whether civil, criminal, administrative or investigative (hereinafter a "proceeding"), by reason of the fact that he or she is or was a Director or an Officer of the Corporation or is or was serving at the request of the Corporation as a Director, Officer, employee or agent of another corporation or of a partnership, joint venture, trust or other enterprise, including service with respect to an employee benefit plan (hereinafter an "indemnitee"), whether the basis of such proceeding is alleged action in an official capacity as a Director, Officer, employee or agent or in any other capacity while serving as a Director, Officer, employee or agent, shall be indemnified and held harmless by the Corporation to the fullest extent authorized by the Delaware General Corporation Law, as the same exists or may hereafter be amended (but, in the case of any such amendment, only to the extent that such amendment permits the Corporation to provide broader indemnification rights than such law permitted the Corporation to provide prior to such amendment), against all expense, liability and loss (including attorneys' fees, judgments, fines, ERISA excise taxes or penalties and amounts paid in settlement) reasonably incurred or suffered by such indemnitee in connection therewith; provided, however, that, except as provided in Section C hereof with respect to proceedings to enforce rights to indemnification, the Corporation shall indemnify any such indemnitee in connection with a proceeding (or part thereof) initiated by such indemnitee only if such proceeding (or part thereof) was authorized by the Board of Directors of the Corporation. D-11 B. The right to indemnification conferred in Section A of this Article TENTH shall include the right to be paid by the Corporation the expenses incurred in defending any such proceeding in advance of its final disposition (hereinafter an "advancement of expenses"); provided, however, that, if the Delaware General Corporation Law requires, an advancement of expenses incurred by an indemnitee in his or her capacity as a Director of Officer (and not in any other capacity in which service was or is rendered by such indemnitee, including, without limitation, service to an employee benefit plan) shall be made only upon delivery to the Corporation of an undertaking (hereinafter an "undertaking"), by or on behalf of such indemnitee, to repay all amounts so advanced if it shall ultimately be determined by final judicial decision from which there is no further right to appeal (hereinafter a "final adjudication") that such indemnitee is not entitled to be indemnified for such expenses under this Section or otherwise. The rights to indemnification and to the advancement of expenses conferred in Sections A and B of this Article TENTH shall be contract rights and such rights shall continue as to an indemnitee who has ceased to be a Director, Officer, employee or agent and shall inure to the benefit of the indemnitee's heirs, executors and administrators. C. If a claim under Section A or B of this Article TENTH is not paid in full by the Corporation within sixty days after a written claim has been received by the Corporation, except in the case of a claim for an advancement of expenses, in which case the applicable period shall be twenty days, the indemnitee may at any time thereafter bring suit against the Corporation to recover the unpaid amount of the claim. If successful in whole or in part in any such suit, or in a suit brought by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking, the indemnitee shall be entitled to be paid also the expense of prosecuting or defending such suit. In (i) any suit brought by the indemnitee to enforce a right to indemnification hereunder (but not in a suit brought by the indemnitee to enforce a right to an advancement of expenses) it shall be a defense that, and (ii) in any suit by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking the Corporation shall be entitled to recover such expenses upon a final adjudication that, the indemnitee has not met any applicable standard for indemnification set forth in the Delaware General Corporation Law. Neither the failure of the Corporation (including its Board of Directors, independent legal counsel, or its stockholders) to have made a determination prior to the commencement of such suit that indemnification of the indemnitee is proper in the circumstances because the indemnitee has met the applicable standard of conduct set forth in the Delaware General Corporation Law, nor an actual determination by the Corporation (including its Board of Directors, independent legal counsel, or its stockholders) that the indemnitee has not met such applicable standard of conduct, shall create a presumption that the indemnitee has not met the applicable standard of conduct or, in the case of such a suit brought by the indemnitee, be a defense to such suit. In any suit brought by the indemnitee to enforce a right to indemnification or to an advancement of expenses hereunder, or by the Corporation to recover an advancement of expenses pursuant to the terms of an undertaking, the burden of proving that the indemnitee is not entitled to be indemnified, or to such advancement of expenses, under this Article TENTH or otherwise shall be on the Corporation. D. The rights to indemnification and to the advancement of expenses conferred in this Article TENTH shall not be exclusive of any other right which any person may have or hereafter acquire under any statute, the Corporation's Certificate of Incorporation, Bylaws, agreement, vote of stockholders or disinterested Directors or otherwise. D-12 E. The Corporation may maintain insurance, at its expense, to protect itself and any Director, Officer, employee or agent of the Corporation or another corporation, partnership, joint venture, trust or other enterprise against any expense, liability or loss, whether or not the Corporation would have the power to indemnify such person against such expense, liability or loss under the Delaware General Corporation Law. F. The Corporation may, to the extent authorized from time to time by the Board of Directors, grant rights to indemnification and to the advancement of expenses to any employee or agent of the Corporation to the fullest extent of the provisions of this Article TENTH with respect to the indemnification and advancement of expenses of Directors and Officers of the Corporation. ELEVENTH: A Director of this Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a Director, except for liability (i) for any breach of the Director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law, or (iv) for any transaction from which the Director derived an improper personal benefit. If the Delaware General Corporation Law is amended to authorize corporate action further eliminating or limiting the personal liability of Directors, then the liability of a Director of the Corporation shall be eliminated or limited to the fullest extent permitted by the Delaware General Corporation Law, as so amended. Any repeal or modification of the foregoing paragraph by the stockholders of the Corporation shall not adversely affect any right or protection of a Director of the Corporation existing at the time of such repeal or modification. TWELFTH: The Corporation reserves the right to amend or repeal any provision contained in this Certificate of Incorporation in the manner prescribed by the laws of the State of Delaware and all rights conferred upon stockholders are granted subject to this reservation; provided, however, that, notwithstanding any other provision of this Certificate of Incorporation or any provision of law which might otherwise permit a lesser vote or no vote, but in addition to any vote of the holders of any class or series of the stock of the Corporation required by law or by this Certificate of Incorporation, the affirmative vote of the holders of at least 80 percent of the voting power of all of the then-outstanding shares of the capital stock of the Corporation entitled to vote generally in the election of Directors (after giving effect to the provisions of Article FOURTH), voting together as a single class, shall be required to amend or repeal this Article TWELFTH, Section C of Article FOURTH, Sections C or D of Article FIFTH, Article SIXTH, Article SEVENTH, Article EIGHTH or Article TENTH. THIRTEENTH: The name and mailing address of the sole incorporator are as follows: Name Mailing Address John J. Gorman, Esquire 5335 Wisconsin Avenue, N.W. Suite 400 Washington, D.C. 20015 D-13 I, THE UNDERSIGNED, being the incorporator, for the purpose of forming a corporation under the laws of the State of Delaware, do make, file and record this Certificate of Incorporation, do certify that the facts herein stated are true, and accordingly, have hereto set my hand this 24th day of June, 2002. /s/ John J. Gorman ----------------------------------- John J. Gorman Incorporator D-14 EXHIBIT E BYLAWS OF THE HOLDING COMPANY BYLAWS OF CITIZENS SOUTH BANKING CORPORATION ARTICLE I - STOCKHOLDERS Section 1. Annual Meeting. An annual meeting of the stockholders, for the election of Directors to succeed those whose terms expire and for the transaction of such other business as may properly come before the meeting, shall be held at such place, on such date, and at such time as the Board of Directors shall each year fix, which date shall be within thirteen (13) months subsequent to the later of the date of incorporation or the last annual meeting of stockholders. Section 2. Special Meetings. Subject to the rights of the holders of any class or series of preferred stock of the Corporation, special meetings of stockholders of the Corporation may be called only by the Board of Directors pursuant to a resolution adopted by a majority of the total number of Directors which the Corporation would have if there were no vacancies on the Board of Directors (hereinafter the "Whole Board"). Section 3. Notice of Meetings. Written notice of the place, date, and time of all meetings of the stockholders shall be given, not less than ten (10) nor more than sixty (60) days before the date on which the meeting is to be held, to each stockholder entitled to vote at such meeting, except as otherwise provided herein or required by law (meaning, here and hereinafter, as required from time to time by the Delaware General Corporation Law or the Certificate of Incorporation of the Corporation). When a meeting is adjourned to another place, date or time, written notice need not be given of the adjourned meeting if the place, date and time thereof are announced at the meeting at which the adjournment is taken; provided, however, that if the date of any adjourned meeting is more than thirty (30) days after the date for which the meeting was originally noticed, or if a new record date is fixed for the adjourned meeting, written notice of the place, date, and time of the adjourned meeting shall be given in conformity herewith. At any adjourned meeting, any business may be transacted which might have been transacted at the original meeting. Section 4. Quorum. At any meeting of the stockholders, the holders of a majority of all of the shares of the stock entitled to vote at the meeting, present in person or by proxy (after giving effect to the provisions of Article FOURTH of the Corporation's Certificate of Incorporation), shall constitute a quorum for all purposes, unless or except to the extent that the presence of a larger number may be required by law. Where a separate vote by a class or classes is required, a majority of those represented by proxy (after giving effect to the provisions of Article FOURTH of the Corporation's Certificate of E-1 Incorporation) shall constitute a quorum entitled to take action with respect to that vote on that matter. If a quorum shall fail to attend any meeting, the chairman of the meeting or the holders of a majority of the shares of stock entitled to vote who are present, in person or by proxy, may adjourn the meeting to another place, date, or time. If a notice of any adjourned special meeting of stockholders is sent to all stockholders entitled to vote thereat, stating that it will be held with those present in person or by proxy constituting a quorum, then except as otherwise required by law, those present in person or by proxy at such adjourned meeting shall constitute a quorum, and all matters shall be determined by a majority of the votes cast at such meeting. Section 5. Organization. Such person as the Board of Directors may have designated or, in the absence of such a person, the Chairman of the Board of the Corporation or, in his or her absence, such person as may be chosen by the holders of a majority of the shares entitled to vote who are present, in person or by proxy, shall call to order any meeting of the stockholders and act as chairman of the meeting. In the absence of the Secretary of the Corporation, the secretary of the meeting shall be such person as the chairman appoints. Section 6. Conduct of Business. (a) The chairman of any meeting of stockholders shall determine the order of business and the procedures at the meeting, including such regulation of the manner of voting and the conduct of discussion as seem to him or her in order. The date and time of the opening and closing of the polls for each matter upon which the stockholders, will vote at the meeting shall be announced at the meeting. (b) At any annual meeting of the stockholders, only such business shall be conducted as shall have been brought before the meeting (i) by or at the direction of the Board of Directors or (ii) by any stockholder of the Corporation who is entitled to vote with respect thereto and who complies with the notice procedures set forth in this Section 6(b). For business to be properly brought before an annual meeting by a stockholder, the business must relate to a proper subject matter for stockholder action and the stockholder must have given timely notice thereof in writing to the Secretary of the Corporation. To be timely, a stockholder's notice must be delivered or mailed to and received at the principal executive offices of the Corporation not less than ninety (90) days prior to the anniversary date of the mailing of proxy materials by the Corporation in connection with the immediately preceding annual meeting of stockholders of the Corporation; provided, however, that in the event that less than one hundred (100) days' notice or prior public disclosure of the date of the meeting is given or made to stockholders, notice by the stockholder to be timely must be received not later than the close of business on the 10th day following the day on which such notice of the date of the annual meeting was mailed or such public disclosure was made. A stockholder's notice to the Secretary shall set forth as to each matter such stockholder proposes to bring before the annual meeting (i) a brief description of the business desired to be brought before E-2 the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and address, as they appear on the Corporation's books, of the stockholder proposing such business, (iii) the class and number of shares of the Corporation's capital stock that are beneficially owned by such stockholder and (iv) any material interest of such stockholder in such business. Notwithstanding anything in these Bylaws to the contrary, no business shall be brought before or conducted at an annual meeting except in accordance with the provisions of this Section 6(b). The Officer of the Corporation or other person presiding over the annual meeting shall, if the facts so warrant, determine and declare to the meeting that business was not properly brought before the meeting in accordance with the provisions of this Section 6(b) and, if he should so determine, he shall so declare to the meeting and any such business so determined to be not properly brought before the meeting shall not be transacted. At any special meeting of the stockholders, only such business shall be conducted as shall have been brought before the meeting by or at the direction of the Board of Directors. (c) Only persons who are nominated in accordance with the procedures set forth in these Bylaws shall be eligible for election as Directors. Nominations of persons for election to the Board of Directors of the Corporation may be made at a meeting of stockholders at which directors are to be elected only (i) by or at the direction of the Board of Directors or (ii) by any stockholder of the Corporation entitled to vote for the election of Directors at the meeting who complies with the notice procedures set forth in this Section 6(c). Such nominations, other than those made by or at the direction of the Board of Directors, shall be made by timely notice in writing to the Secretary of the Corporation. To be timely, a stockholder's notice shall be delivered or mailed to and received at the principal executive offices of the Corporation not less than ninety (90) days prior to the anniversary date of the mailing of proxy materials by the Corporation in connection with the immediately preceding annual meeting of stockholders of the Corporation; provided, however, that in the event that less than one hundred (100) days' notice or prior disclosure of the date of the meeting is given or made to stockholders, notice by the stockholder to be timely must be so received not later than the close of business on the 10th day following the day on which such notice of the date of the meeting was mailed or such public disclosure was made. Such stockholder's notice shall set forth (i) as to each person whom such stockholder proposes to nominate for election or re-election as a Director, all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (including such person's written consent to being named in the proxy statement as a nominee and to serving as a director if elected); and (ii) as to the stockholder giving the notice (x) the name and address, as they appear on the Corporation's books, of such stockholder and (y) the class and number of shares of the Corporation's capital stock that are beneficially owned by such stockholder. At the request of the Board of Directors, any person nominated by the Board of Directors for election as a Director shall furnish to the Secretary of the Corporation that information required to be set forth in a stockholder's notice of nomination which pertains to the nominee. No person shall be eligible for election as a Director of the Corporation unless nominated in accordance with the provisions of this Section 6(c). The Officer of the Corporation or other person presiding at the meeting shall, if the facts so warrant, determine that a nomination was not made in accordance with such provisions and, if he or she shall so determine, he or she shall so declare to the meeting and the defective nomination shall be disregarded. E-3 Section 7. Proxies and Voting. At any meeting of the stockholders, every stockholder entitled to vote may vote in person or by proxy authorized by an instrument in writing filed in accordance with the procedure established for the meeting. Any facsimile telecommunication or other reliable reproduction of the writing or transmission created pursuant to this paragraph, may be substituted or used in lieu of the original writing or transmission for any and all purposes for which the original writing or transmission could be used, provided that such copy, facsimile telecommunication or other reproduction shall be a complete reproduction of the entire original writing or transmission. All voting, including on the election of Directors but excepting where otherwise required by law or by the governing documents of the Corporation, may be made by a voice vote; provided, however, that upon demand therefor by a stockholder entitled to vote or his or her proxy, a stock vote shall be taken. Every stock vote shall be taken by ballot, each of which shall state the name of the stockholder or proxy voting and such other information as may be required under the procedures established for the meeting. The Corporation shall, in advance of any meeting of stockholders, appoint one or more inspectors to act at the meeting and make a written report thereof. The Corporation may designate one or more persons as alternate inspectors to replace any inspector who fails to act. If no inspector or alternate is able to act at a meeting of stockholders, the person presiding at the meeting shall appoint one or more inspectors to act at the meeting. Each inspector, before entering upon the discharge of his duties, shall take and sign an oath faithfully to execute the duties of inspector with strict impartiality and according to the best of his ability. All elections of Directors shall be determined by a plurality of the votes cast, and except as otherwise required by law, all other matters shall be determined by a majority of the votes cast. Section 8. Stock List. A complete list of stockholders entitled to vote at any meeting of stockholders, arranged in alphabetical order for each class of stock and showing the address of each such stockholder and the number of shares registered in his or her name, shall be open to the examination of any such stockholder, for any purpose germane to the meeting, during ordinary business hours for a period of at least ten (10) days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or if not so specified, at the place where the meeting is to be held. The stock list shall also be kept at the place of the meeting during the whole time thereof and shall be open to the examination of any such stockholder who is present. This list shall presumptively determine the identity of the stockholders entitled to vote at the meeting and the number of shares held by each of them. Section 9. Consent of Stockholders in Lieu of Meeting. Subject to the rights of the holders of any class of series of preferred stock of the Corporation, any action required or permitted to be taken by the stockholders of the Corporation must be effected E-4 at an annual or special meeting of stockholders of the Corporation and may not be effected by any consent in writing by such stockholders. ARTICLE II - BOARD OF DIRECTORS Section 1. General Powers Number and Term of Office. The business and affairs of the Corporation shall be under the direction of its Board of Directors. The number of Directors who shall constitute the Whole Board shall be such number as the Board of Directors shall from time to time have designated, except in the absence of such designation such number shall be eight (8). The Board of Directors shall annually elect a Chairman of the Board from among its members who shall, when present, preside at its meetings. The Directors, other than those who may be elected by the holders of any class or series of Preferred Stock, shall be divided, with respect to the time for which they severally hold office, into three classes, with the term of office of the first class to expire at the first annual meeting of stockholders, the term of office of the second class to expire at the annual meeting of stockholders one year thereafter and the term of office of the third class to expire at the annual meeting of stockholders two years, thereafter, with each Director to hold office until his or her successor shall have been duly elected and qualified. At each annual meeting of stockholders, Directors elected to succeed those Directors whose terms then expire shall be elected for a term of office to expire at the third succeeding annual meeting of stockholders after their election, with each Director to hold office until his or her successor shall have been duly elected and qualified. Section 2. Vacancies and Newly Created Directorships. Subject to the rights of the holders of any class or series of Preferred Stock, and unless the Board of Directors otherwise determines, newly created directorships resulting from any increase in the authorized number of directors or any vacancies in the Board of Directors resulting from death, resignation, retirement, disqualification, removal from office or other cause may be filled only by a majority vote of the Directors then in office, though less than a quorum, and Directors so chosen shall hold office for a term expiring at the annual meeting of stockholders at which the term of office of the class to which they have been elected expires and until such Director's successor shall have been duly elected and qualified. No decrease in the number of authorized directors constituting the Board shall shorten the term of any incumbent Director. Section 3. Regular Meetings. Regular meetings of the Board of Directors shall be held at such place or places, on such date or dates, and at such time or times as shall have been established by the Board of Directors and publicized among all Directors. A notice of each regular meeting shall not be required. Section 4. Special Meetings. Special meetings of the Board of Directors may be called by one-third (1/3) of the Directors then in office (rounded up to the nearest whole number), by the Chairman of the Board or the President and shall be held at such place, on such date, and at such time as they, or he or she, shall E-5 fix. Notice of the place, date, and time of each such special meeting shall be given each Director by whom it is not waived by mailing written notice not less than five (5) days before the meeting or by telegraphing or telexing or by facsimile transmission of the same not less than twenty-four (24) hours before the meeting. Unless otherwise indicated in the notice thereof, any and all business may be transacted at a special meeting. Section 5. Quorum. At any meeting of the Board of Directors, a majority of the Whole Board shall constitute a quorum for all purposes. If a quorum shall fail to attend any meeting, a majority of those present may adjourn the meeting to another place, date, or time, without further notice or waiver thereof. Section 6. Participation in Meetings By Conference Telephone. Members of the Board of Directors, or of any committee thereof, may participate in a meeting of such Board or committee by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other and such participation shall constitute presence in person at such meeting. Section 7. Conduct of Business. At any meeting of the Board of Directors, business shall be transacted in such order and manner as the Board may from time to time determine, and all matters shall be determined by the vote of a majority of the Directors present, except as otherwise provided herein or required by law. Action may be taken by the Board of Directors without a meeting if all members thereof consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board of Directors. Section 8. Powers. The Board of Directors may, except as otherwise required by law, exercise all such powers and do all such acts and things as may be exercised or done by the Corporation, including, without limiting the generality of the foregoing, the unqualified power: (1) To declare dividends, from time to time in accordance with law; (2) To purchase or otherwise acquire any property, rights or privileges on such terms as it shall determine; (3) To authorize the creation, making and issuance, in such form as it may determine, of written obligations of every kind, negotiable or non-negotiable, secured or unsecured, and to do all things necessary in connection therewith; (4) To remove any Officer of the Corporation with or without cause, and from time to time to devolve the powers and duties of any Officer upon any other person for the time being; E-6 (5) To confer upon any Officer of the Corporation the power to appoint, remove and suspend subordinate Officers, employees and agents; (6) To adopt from time to time such stock, option, stock purchase, bonus or other compensation plans for Directors, Officers, employees and agents of the Corporation and its subsidiaries as it may determine; (7) To adopt from time to time such insurance, retirement, and other benefit plans for Directors, Officers, employees and agents of the Corporation and its subsidiaries as it may determine; and, (8) To adopt from time to time regulations, not inconsistent with these Bylaws, for the management of the Corporation's business and affairs. Section 9. Compensation of Directors. Directors, as such, may receive, pursuant to resolution of the Board of Directors, fixed fees and other compensation for their services as Directors, including, without limitation, their services as members of committees of the Board of Directors. Section 10. Qualifications. Any person appointed or elected to the Board of Directors shall, in order to qualify as such, shall own at least 100 shares of the Corporation's common stock, and shall reside, or work, in a county in which Citizens South Bank (the banking subsidiary of the Corporation) maintains an office (at the time of appointment/election) or in a county contiguous to a county in which Citizens South Bank maintains an office. ARTICLE III - COMMITTEES Section 1. Committees of the Board of Directors. The Board of Directors, by a vote of a majority of the Board of Directors, may from time to time designate committees of the Board, with such lawfully delegable powers and duties as it thereby confers, to serve at the pleasure of the Board and shall, for these committees and any others provided for herein, elect a Director or Directors to serve as the member or members, designating, if it desires, other Directors as alternate members who may replace any absent or disqualified member at any meeting of the committee. Any committee so designated may exercise the power and authority of the Board of Directors to declare a dividend, to authorize the issuance of stock or to adopt a certificate of ownership and merger pursuant to Section 253 of the Delaware General Corporation Law if the resolution which designates the committee or a supplemental resolution of the Board of Directors shall so provide. In the absence or disqualification of any member of any committee and any alternate member in his or her place, the member or members of the committee present at the meeting and not disqualified from voting, whether or not he or she or they constitute a quorum, may by E-7 unanimous vote appoint another member of the Board of Directors to act at the meeting in the place of the absent or disqualified member. Section 2. Conduct of Business. Each committee may determine the procedural rules for meeting and conducting its business and shall act in accordance therewith, except as otherwise provided herein or required by law. Adequate provision shall be made for notice to members of all meetings; one-third (1/3) of the members shall constitute a quorum unless the committee shall consist of one (1) or two (2) members, in which event one (1) member shall constitute a quorum; and all matters shall be determined by a majority vote of the members present. Action may be taken by any committee without a meeting if all members thereof consent thereto in writing, and the writing or writings are filed with the minutes of the proceedings of such committee. Section 3. Nominating Committee The Board of Directors may appoint a Nominating Committee of the Board, consisting of not less than three (3) members. The Nominating Committee shall have authority (a) to review any nominations for election to the Board of Directors made by a stockholder of the Corporation pursuant to Section 6(c)(ii) of Article I of these Bylaws in order to determine compliance with such Bylaw and (b) to recommend to the Whole Board nominees for election to the Board of Directors to replace those Directors whose terms expire at the annual meeting of stockholders next ensuing. ARTICLE IV - OFFICERS Section 1. Generally. (a) The Board of Directors as soon as may be practicable after the annual meeting of stockholders shall choose a Chairman of the Board, a Chief Executive Officer and President, one or more Vice Presidents, a Secretary and a Treasurer and from time to time may choose such other officers as it may deem proper. The Chairman of the Board shall be chosen from among the Directors. Any number of offices may be held by the same person. (b) The term of office of all Officers shall be until the next annual election of Officers and until their respective successors are chosen but any Officer may be removed from office at any time by the affirmative vote of a majority of the authorized number of Directors then constituting the Board of Directors. (c) All Officers chosen by the Board of Directors shall have such powers and duties as generally pertain to their respective Offices, subject to the specific provisions of this ARTICLE IV. Such officers shall also have such powers and duties as from time to time may be conferred by the Board of Directors or by any committee thereof. Section 2. Chairman of the Board of Directors. The Chairman of the Board shall, subject to the provisions of these Bylaws and to the direction of the Board of Directors, serve in general executive capacity and unless the Board has E-8 designated another person, when present, shall preside at all meetings of the stockholders of the Corporation. The Chairman of the Board shall perform all duties and have all powers which are commonly incident to the office of Chairman of the Board or which are delegated to him or her by the Board of Directors. He or she shall have power to sign all stock certificates, contracts and other instruments of the Corporation which are authorized. Section 3. President and Chief Executive Officer. The President and Chief Executive Officer (the "President") shall have general responsibility for the management and control of the business and affairs of the Corporation and shall perform all duties and have all powers which are commonly incident to the offices of President and Chief Executive Officer or which are delegated to him or her by the Board of Directors. Subject to the direction of the Board of Directors, the President shall have power to sign all stock certificates, contracts and other instruments of the Corporation which are authorized and shall have general supervision of all of the other Officers (other than the Chairman of the Board), employees and agents of the Corporation. Section 4. Vice President. The Vice President or Vice Presidents shall perform the duties of the President in his absence or during his inability to act. In addition, the Vice Presidents shall perform the duties and exercise the powers usually incident to their respective offices and/or such other duties and powers as may be properly assigned to them by the Board of Directors, the Chairman of the Board or the President. A Vice President or Vice Presidents may be designated as Executive Vice President or Senior Vice President. Section 5. Secretary. The Secretary or Assistant Secretary shall issue notices of meetings, shall keep their minutes, shall have charge of the seal and the corporate books, shall perform such other duties and exercise such other powers as are usually incident to such office and/or such other duties and powers as are properly assigned thereto by the Board of Directors, the Chairman of the Board or the President. Subject to the direction of the Board of Directors, the Secretary shall have the power to sign all stock certificates. Section 6. Treasurer. The Treasurer shall be the Comptroller of the Corporation and shall have the responsibility for maintaining the financial records of the Corporation. He or she shall make such disbursements of the funds of the Corporation as are authorized and shall render from time to time an account of all such transactions and of the financial condition of the Corporation. The Treasurer shall also perform such other duties as the Board of Directors may from time to time prescribe. Subject to the direction of the Board of Directors, the Treasurer shall have the power to sign all stock certificates. E-9 Section 7. Assistant Secretaries and Other Officers. The Board of Directors may appoint one or more Assistant Secretaries and such other Officers who shall have such powers and shall perform such duties as are provided in these Bylaws or as may be assigned to them by the Board of Directors, the Chairman of the Board or the President. Section 8. Action with Respect to Securities of Other Corporations. Unless otherwise directed by the Board of Directors, the President or any Officer of the Corporation authorized by the President shall have power to vote and otherwise act on behalf of the Corporation, in person or by proxy, at any meeting of stockholders of or with respect to, any action of stockholders of any other corporation in which this Corporation may hold securities and otherwise to exercise any and all rights and powers which this Corporation may possess by reason of its ownership of securities in such other corporation. ARTICLE V - STOCK Section 1. Certificates of Stock. Each stockholder shall be entitled to a certificate signed by, or in the name of the Corporation by, the Chairman of the Board or the President, and by the Secretary or an Assistant Secretary, or any Treasurer or Assistant Treasurer, certifying the number of shares owned by him or her. Any or all of the signatures on the certificate may be by facsimile. Section 2. Transfers of Stock. Transfers of stock shall be made only upon the transfer books of the Corporation kept at an office of the Corporation or by transfer agents designated to transfer shares of the stock of the Corporation. Except where a certificate is issued in accordance with Section 4 of Article V of these Bylaws, an outstanding certificate for the number of shares involved shall be surrendered for cancellation before a new certificate is issued therefor. Section 3. Record Date. In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders, or to receive payment of any dividend or other distribution or allotment of any rights or to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix a record date, which record date shall not precede the date on which the resolution fixing the record date is adopted and which record date shall not be more than sixty (60) nor less than ten (10) days before the date of any meeting of stockholders, nor more than sixty (60) days prior to the time for such other action as hereinbefore described; provided, however, that if no record date is fixed by the Board of Directors, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given or, if notice is waived, at the close of business on the next day preceding the day on which the meeting is held, and, for determining stockholders entitled to receive payment of any dividend or other distribution or allotment or rights or to exercise any rights of change, conversion or exchange E-10 of stock or for any other purpose, the record date shall be at the close of business on the day on which the Board of Directors adopts a resolution relating thereto. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. Section 4. Lost, Stolen or Destroyed Certificates. In the event of the loss, theft or destruction of any certificate of stock, another may be issued in its place pursuant to such regulations as the Board of Directors may establish concerning proof of such loss, theft or destruction and concerning the giving of a satisfactory bond or bonds of indemnity. Section 5. Regulations. The issue, transfer, conversion and registration of certificates of stock shall be governed by such other regulations as the Board of Directors may establish. ARTICLE VI - NOTICES Section 1. Notices. Except as otherwise specifically provided herein or required by law, all notices required to be given to any stockholder, Director, Officer, employee or agent shall be in writing and may in every instance be effectively given by hand delivery to the recipient thereof, by depositing such notice in the mails, postage paid, or by sending such notice by prepaid telegram or mailgram or other courier. Any such notice shall be addressed to such stockholder, Director, Officer, employee or agent at his or her last known address as the same appears on the books of the Corporation. The time when such notice is received, if hand delivered, or dispatched, if delivered through the mails or by telegram or mailgram or other courier, shall be the time of the giving of the notice. Section 2. Waivers. A written waiver of any notice, signed by a stockholder, Director, Officer, employee or agent, whether before or after the time of the event for which notice is to be given, shall be deemed equivalent to the notice required to be given to such stockholder, Director, Officer, employee or agent. Neither the business nor the purpose of any meeting need be specified in such a waiver. ARTICLE VII - MISCELLANEOUS Section 1. Facsimile Signatures. In addition to the provisions for use of facsimile signatures elsewhere specifically authorized in these Bylaws, facsimile signatures of any officer or officers of the Corporation may be used whenever and as authorized by the Board of Directors or a committee thereof. E-11 Section 2. Corporate Seal. The Board of Directors may provide a suitable seal, containing the name of the Corporation, which seal shall be in the charge of the Secretary. If and when so directed by the Board of Directors or a committee thereof, duplicates of the seal may be kept and used by the Treasurer or by an Assistant Secretary or an assistant to the Treasurer. Section 3. Reliance Upon Books, Reports and Records. Each Director, each member of any committee designated by the Board of Directors, and each Officer of the Corporation shall, in the performance of his or her duties, be fully protected in relying in good faith upon the books of account or other records of the Corporation and upon such information, opinions, reports or statements presented to the Corporation by any of its Officers or employees, or committees of the Board of Directors so designated, or by any other person as to matters which such Director or committee member reasonably believes are within such other person's professional or expert competence and who has been selected with reasonable care by or on behalf of the Corporation. Section 4. Fiscal Year. The fiscal year of the Corporation shall end on December 31 of every year. Section 5. Time Periods. In applying any provision of these Bylaws which requires that an act be done or not be done a specified number of days prior to an event or that an act be done during a period of a specified number of days prior to an event, calendar days shall be used, the day of the doing of the act shall be excluded, and the day of the event shall be included. ARTICLE VIII - AMENDMENTS The Board of Directors may amend, alter or repeal these Bylaws at any meeting of the Board, provided notice of the proposed change was given not less than two days prior to the meeting. The stockholders shall also have power to amend, alter or repeal these Bylaws at any meeting of stockholders provided notice of the proposed change was given in the notice of the meeting; provided, however, that, notwithstanding any other provisions of the Bylaws or any provision of law which might otherwise permit a lesser vote or no vote, but in addition to any affirmative vote of the holders of any particular class or series of the voting stock required by law, the Certificate of Incorporation, any Preferred Stock Designation or these Bylaws, the affirmative votes of the holders of at least 80% of the voting power of all the then-outstanding shares of the Voting Stock, voting together as a single class, shall be required to alter, amend or repeal any provisions of these Bylaws. E-12 EX-4 6 dex4.txt EXHIBIT 4 EXHIBIT 4 Exhibit 4 INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE CITIZENS SOUTH BANKING CORPORATION GASTONIA, NORTH CAROLINA $0.01 par value common stock--fully paid and non-assessable This certifies that _____________________________ is the owner of __________ shares of the common stock of Citizens South Banking Corporation (the "Corporation"), a Delaware corporation. The shares evidenced by this certificate are transferable only on the stock transfer books of the Corporation by the holder of record hereof, in person or by his duly authorized attorney or legal representative, upon surrender of this certificate properly endorsed. This Certificate is not valid until countersigned and registered by the Corporation's transfer agent and registrar. This security is not a deposit or account and is not federally insured or guaranteed. IN WITNESS WHEREOF, the Corporation has caused this certificate to be executed by the facsimile signatures of its duly authorized officers and has caused its seal to be affixed hereto. DATED:____________________ __________________________ __________________________ Secretary (SEAL) President The shares evidenced by this Certificate are subject to a limitation contained in the Certificate of Incorporation to the effect that in no event shall any record owner of any outstanding Common Stock which is beneficially owned, directly or indirectly, by a person who beneficially owns in excess of 10% of the outstanding shares of Common Stock (the "Limit") be entitled or permitted to any vote in respect of shares held in excess of the Limit. The Board of Directors of the Corporation is authorized by resolution or resolutions, from time to time adopted, to provide for the issuance of serial preferred stock in series and to fix and state the voting powers, designations, preferences, limitations and restrictions thereof. The Corporation will furnish to any shareholder upon request and without charge a full description of each class of stock and any series thereof. The shares represented by this Certificate may not be cumulatively voted on any matter. The Certificate of Incorporation requires the affirmative vote of the holders of at least 80% of the voting stock of the Corporation, voting together as a single class, to approve certain transactions and to amend certain provisions of the Certificate of Incorporation. The following abbreviations when used in the inscription on the face of this certificate, shall be construed as though they were written out in full according to applicable laws or regulations. TEN COM - as tenants in common UNIF GIFT MIN ACT - ___________________ Custodian _____________ (Cust) (Minor) TEN ENT - as tenants by the entireties Under Uniform Transfers to Minors Act JT TEN - as joint tenants with right of survivorship and not as __________________________________________ tenants in common (State)
Additional abbreviations may also be used though not in the above list For value received, _____________________ hereby sell, assign and transfer unto PLEASE INSERT SOCIAL SECURITY NUMBER OR OTHER IDENTIFYING NUMBER ________________________________________________________________ ________________________________________________________________ _______________________________________________________________________________ (please print or typewrite name and address including postal zip code of assignee) _______________________________________________________________________________ _____________________________________________________________________ Shares of the Common Stock represented by the within Certificate, and do hereby irrevocably constitute and appoint_____________________________________________ Attorney to transfer the said shares on the books of the within named corporation with full power of substitution in the premises. Dated, _____________________________ In the presence of Signature: _____________________________________ _____________________________________ NOTE: THE SIGNATURE TO THIS ASSIGNMENT MUST CORRESPOND WITH THE NAME OF THE STOCKHOLDER(S) AS WRITTEN UPON THE FACE OF THE CERTIFICATE, IN EVERY PARTICULAR, WITHOUT ALTERATION OR ENLARGEMENT, OR ANY CHANGE WHATSOEVER. EX-5 7 dex5.txt EXHIBIT 5 EXHIBIT 5 Exhibit 5 [LETTERHEAD OF LUSE GORMAN POMERENK & SCHICK, P.C. APPEARS HERE] (202) 274-2000 June 26, 2002 The Board of Directors Citizens South Banking Corporation 245 West Main Avenue Gastonia, North Carolina 28052 Re: Citizens South Banking Corporation Common Stock Par Value $.01 Per Share -------------------------------------- Ladies and Gentlemen: You have requested the opinion of this firm as to certain matters in connection with the offer and sale (the "Offering") of the common stock, par value $0.01 per share ("Common Stock") of Citizens South Banking Corporation (the "Company"). We have reviewed the Company's Certificate of Incorporation, Registration Statement on Form S-1 (the "Form S-1"), as well as applicable statutes and regulations governing the Company and the offer and sale of the Common Stock. We are of the opinion that upon the declaration of effectiveness of the Form S-1, the Common Stock, when sold, will be legally issued, fully paid and non-assessable. This Opinion has been prepared for the use of the Company in connection with the Form S-1. We hereby consent to our firm being referenced under the caption "Legal Matters." Very truly yours, /s/ Luse Gorman Pomerenk & Schick --------------------------------- LUSE GORMAN POMERENK & SCHICK A PROFESSIONAL CORPORATION EX-8.2 8 dex82.txt EXHIBIT 8.2 EXHIBIT 8.2 Exhibit 8.2 [Letterhead of RP Financial, LC.] June 25, 2002 Board of Directors Citizens South Holdings, MHC Citizens South Banking Corporation Citizen South Bank 245 West Main Avenue Gastonia, North Carolina 28052 Re: Plan of Conversion and Reorganization Citizens South Holdings, MHC Citizens South Banking Corporation Members of the Boards of Directors: All capitalized terms not otherwise defined in this letter have the meanings given such terms in the Plan of Conversion and Reorganization (the "Plan") adopted by the Board of Directors of Citizens South Holdings, MHC. (the "Mutual Holding Company") and Citizens South Banking Corporation (the "Company"). The Plan provides for the conversion of the Mutual Holding Company into the capital stock form of organization. The Mutual Holding Company currently owns a majority of the common stock of the Company, a federally chartered stock holding company, which owns 100 percent of the common stock of Citizens South Bank (the "Bank"), a federally chartered community bank headquartered in Gastonia, North Carolina. Pursuant to the Plan, the Company will sell shares of common stock in an offering that will represent the ownership interest in the Company now owned by the Mutual Holding Company. We understand that in accordance with the Plan, subscription rights to purchase shares of common stock in the Holding Company are to be issued to: (1) Eligible Account Holders; (2) Tax-Qualified Plans; (3) Supplemental Eligible Account Holders; and (4) Other Members. Based solely upon our observation that the subscription rights will be available to such parties without cost, will be legally non-transferable and of short duration, and will afford such parties the right only to purchase shares of common stock at the same price as will be paid by members of the general public in the community offering, but without undertaking any independent investigation of state or federal law or the position of the Internal Revenue Service with respect to this issue, we are of the belief that, as a factual matter: (1) the subscription rights will have no ascertainable market value; and, (2) the price at which the subscription rights are exercisable will not be more or less than the pro forma market value of the shares upon issuance. Changes in the local and national economy, the legislative and regulatory environment, the stock market, interest rates, and other external forces (such as natural disasters or significant world events) may occur from time to time, often with great unpredictability and may materially impact the value of thrift stocks as a whole or the Company's value alone. Accordingly, no assurance can be given that persons who subscribe to shares of common stock in the subscription offering will thereafter be able to buy or sell such shares at the same price paid in the subscription offering. Sincerely, /s/ RP Financial, LC. RP FINANCIAL, LC. EX-21 9 dex21.txt EXHIBIT 21 EXHIBIT 21 Exhibit 21 SUBSIDIARIES OF THE REGISTRANT The following is a list of the subsidiaries of Citizens South Banking Corporation following the Conversion: Name State of Incorporation Citizens South Bank Federal Citizens South Financial Services, Inc., d.b.a. Citizens South Investment Services North Carolina EX-23.2 10 dex232.txt EXHIBIT 23.2 EXHIBIT 23.2 Exhibit 23.2 CONSENT OF INDEPENDENT AUDITORS We have issued our report dated January 30, 2002 accompanying the financial statements of Citizens South Banking Corporation (formerly Gaston Federal Bancorp, Inc.) and subsidiaries as contained in the Rregistration Statement on Form S-1 and the Form AC of Citizens South Banking Corporation and subsidiaries to be filed with the Securities and Exchange Commission and the Office of Thrift Supervision on or about June 25, 2002. We consent to the use of the aformentioned reports in the Registration Statement and Prospectus and to the use of our name as it appears under the caption "Experts" in the Prospectus. /s/ Cherry, Bekaert & Holland, L.L.P. Gastonia, North Carolina June 25, 2002 EX-23.3 11 dex233.txt EXHIBIT 23.3 EXHIBIT 23.3 Exhibit 23.3 [Letterhead of RP Financial, L.C.] June 25, 2002 Board of Directors Citizens South Holdings, MHC Citizens South Banking Corporation Citizens South Bank 245 West Main Avenue Gastonia, North Carolina 28052 Members of the Boards of Directors: We hereby consent to the use of our firm's name in the Form AC Application for Conversion, and any amendments thereto, and in the Registration Statement on Form S-1, and any amendments thereto. We also hereby consent to the inclusion of, summary of and references to our Appraisal and our statement concerning subscription rights in such filings including the prospectus of Citizens South Banking Corporation. Sincerely, RP FINANCIAL, LC. /s/ Gregory E. Dunn Gregory E. Dunn Senior Vice President EX-23.4 12 dex234.txt EXHIBIT 23.4 EXHIBIT 23.4 Exhibit 23.4 Consent of Independent Auditors We consent to the reference to our firm under the caption "Experts" and to the use of our report dated November 17, 2000, with respect to the consolidated financial statements of Innes Street Financial Corporation for the years ended September 30, 2000 and 1999 included in the Registration Statement (Form S-1 No. 33-00000) and related Prospectus for the registration of up to 4,600,000 shares of its common stock and the Form AC of Citizens South Banking Corporation to be filed with the Securities and Exchange Commission and the Office of Thrift Supervision. /s/ Ernst & Young LLP Ernst & Young LLP Greensboro, North Carolina June 25, 2002 EX-99.1 13 dex991.txt EXHIBIT 99.1 EXHIBIT 99.1 RP FINANCIAL, LC. Exhibit 99.1 - ----------------------------------------------- Financial Services Industry Consultants May 22, 2002 Mr. Kim Stuart Price President and Chief Executive Officer Citizens South Banking Corporation 245 West Main Avenue Gastonia, North Carolina 28052 Dear Mr. Price: This letter sets forth the agreement between Citizens South Banking Corporation ("Citizens South" or the "Company"), subsidiary of Citizens South Holdings, MHC, Gastonia, North Carolina (the "MHC"), and RP Financial, LC. ("RP Financial") for independent conversion appraisal services pertaining to the mutual-to-stock conversion of the MHC. The specific appraisal services to be rendered by RP Financial are described below. These appraisal services will be rendered by a team of two senior consultants on staff and will be directed by the undersigned. Description of Appraisal Services In conjunction with preparing the appraisal report, RP Financial will conduct a financial due diligence, including on-site interviews of senior management and reviews of financial and other documents and records, to gain insight into the operations, financial condition, profitability, market area, risks and various internal and external factors of Citizens South, all of which will be considered in estimating the pro forma market value of the Company. RP Financial will prepare a detailed written valuation report of the Company that will be fully consistent with applicable federal regulatory guidelines and standard pro forma valuation practices. The appraisal report will include an analysis of the Company's financial condition and operating results, as well as an assessment of the Company's interest rate risk, credit risk and liquidity risk. The appraisal report will describe the Company's business strategies, market area, prospects for the future and the intended use of proceeds. A peer group analysis relative to comparable publicly-traded savings and banking institutions will be conducted for the purpose of determining appropriate valuation adjustments for the Company relative to the peer group. We will review pertinent sections of the Company's prospectus and hold discussions with the Company to obtain necessary data and information for the appraisal report, including the impact of key deal elements on the pro forma market value, such as dividend policy, use of proceeds and reinvestment rate, tax rate, offering expenses, and the characteristics of stock plans. - -------------------------------------------------------------------------------- Washington Headquarters Rosslyn Center Telephone: (703) 528-1700 1700 North Moore Street, Suite 2210 Fax No.: (703) 528-1788 Arlington, VA 22209 Toll-Free No.: (866) 723-0594 www.rpfinancial.com E-Mail: wpommerening@rpfinancial.com Mr. Kim Stuart Price May 22, 2002 Page 2 The appraisal report will establish a midpoint pro forma market value. The appraisal report may be periodically updated throughout the conversion process as appropriate. There will be at least one updated valuation that would be prepared at the time of the closing of the stock offering. RP Financial agrees to deliver the original appraisal report and subsequent updates, in writing, to the Company at the above address in conjunction with the filing of the regulatory applications. Subsequent updates will be filed promptly as certain events occur which would warrant the preparation and filing of such valuation updates. Further, RP Financial agrees to perform such other services as are necessary or required in connection with the regulatory review of the appraisal and respond to the regulatory comments, if any, regarding the valuation appraisal and subsequent updates. RP Financial expects to formally present the appraisal report, including the appraisal methodology, peer group selection and assumptions, to the Board of Trustees for review and acceptance. Fee Structure and Payment Schedule The Company agrees to pay RP Financial a fixed fee of $35,000 for preparation of the original appraisal and $5,000 per updated appraisal, plus reimbursable expenses. Payment of these fees shall be made according to the following schedule: . $5,000 upon execution of the letter of agreement engaging RP Financial's appraisal services; . $30,000 upon delivery of the original appraisal report concurrent with filing the regulatory applications; and . $5,000 upon delivery of each updated appraisal (there will be at least one updated appraisal prepared concurrent with the end of the offering). The Company will reimburse RP Financial for reasonable out-of-pocket expenses incurred in preparation of the valuation. Such out-of-pocket expenses will likely include travel, printing, telephone, facsimile, shipping, computer and data services. RP Financial will agree to limit reimbursable expenses in conjunction with the appraisal and business planning engagements to $7,500, subject to written authorization from the Company to exceed such level. In the event the Company shall, for any reason, discontinue the proposed transaction prior to delivery of the completed documents set forth above and payment of the respective progress payment fees, the Company agrees to compensate RP Financial according to RP Financial's standard billing rates for consulting services based on accumulated and verifiable time expenses, not to exceed the respective fee caps noted above, after applying full credit to the initial $5,000 retainer fee towards such payment. RP Financial's standard billing rates range from $75 per hour for research associates to $250 per hour for managing directors. Mr. Kim Stuart Price May 22, 2002 Page 3 If during the course of the proposed transaction, unforeseen events occur so as to materially change the nature or the work content of the services described in this contract, the terms of said contract shall be subject to renegotiation by the Company and RP Financial. Such unforeseen events shall include, but not be limited to, major changes in the conversion regulations, appraisal guidelines or processing procedures as they relate to conversion appraisals, major changes in management or procedures, operating policies or philosophies, and excessive delays or suspension of processing of conversion applications by the regulators such that completion of the conversion transaction requires the preparation by RP Financial of a new appraisal. Representations and Warranties The Company and RP Financial agree to the following: 1. The Company agrees to make available or to supply to RP Financial such information with respect to its business and financial condition as RP Financial may reasonably request in order to provide the aforesaid valuation. Such information heretofore or hereafter supplied or made available to RP Financial shall include: annual financial statements, periodic regulatory filings and material agreements, debt instruments, off balance sheet assets or liabilities, commitments and contingencies, unrealized gains or losses and corporate books and records. All information provided by the Company to RP Financial shall remain strictly confidential (unless such information is otherwise made available to the public), and if the conversion is not consummated or the services of RP Financial are terminated hereunder, RP Financial shall upon request promptly return to the Company the original and any copies of such information. 2. The Company hereby represents and warrants to RP Financial that any information provided to RP Financial does not and will not, to the best of the Company's knowledge, at the times it is provided to RP Financial, contain any untrue statement of a material fact or in response to informational requests by RP Financial fail to state a material fact necessary to make the statements therein not false or misleading in light of the circumstances under which they were made. 3. (a) The Company agrees that it will indemnify and hold harmless RP Financial, any affiliates of RP Financial, the respective directors, officers, agents and employees of RP Financial or their successors and assigns who act for or on behalf of RP Financial in connection with the services called for under this agreement (hereinafter referred to as "RP Financial"), from and against any and all losses, claims, damages and liabilities (including, but not limited to, reasonable attorneys fees, all losses and expenses in connection with claims under the federal securities laws) attributable to (i) any untrue statement or alleged untrue statement of a material fact contained in the financial statements or other information furnished or otherwise provided by the Company to RP Financial, either orally or in writing; (ii) the omission or alleged omission of a material fact from the financial statements or other information furnished or otherwise made available by the Company to RP Financial; or (iii) any action or omission to act by the Company, or the Company's respective officers, directors, employees or agents, which action or omission is Mr. Kim Stuart Price May 22, 2002 Page 4 undertaken in bad faith or is negligent. The Company will be under no obligation to indemnify RP Financial hereunder if a court determines that RP Financial was negligent or acted in bad faith with respect to any actions or omissions of RP Financial related to a matter for which indemnification is sought hereunder. Reasonable time devoted by RP Financial to situations for which indemnification is provided hereunder, shall be an indemnifiable cost payable by the Company at the normal hourly professional rate chargeable by such employee. (b) RP Financial shall give written notice to the Company of such claim or facts within thirty days of the assertion of any claim or discovery of material facts upon which the RP Financial intends to base a claim for indemnification hereunder, including the name of counsel that RP Financial intends to engage in connection with any indemnification related matter. In the event the Company elects, within seven days of the receipt of the original notice thereof, to contest such claim by written notice to RP Financial, the Company shall not be obligated to make payments under Section 3(c), but RP Financial will be entitled to be paid any amounts payable by the Company hereunder, together with interest on such costs from the date incurred at the annual rate of prime plus two percent within five days after the final determination of such contest either by written acknowledgement of the Company or a final judgment of a court of competent jurisdiction, unless it is determined in accordance with Section 3(c) hereof that RP Financial is not entitled to indemnity hereunder. If the Company does not so elect to contest a claim for indemnification by RP Financial hereunder, RP Financial shall (subject to the Company's receipt of the written statement and undertaking under Section 3(c) hereof) be paid promptly and in any event within thirty days after receipt by the Company of billing statements or invoices for which RP Financial is entitled to reimbursement under Section 3(c) hereof. (c) Subject to the Company's right to contest under Section 3(b) hereof, the Company shall pay for or reimburse the reasonable expenses, including attorneys' fees, incurred by RP Financial in advance of the final disposition of any proceeding within thirty days of the receipt of such request if RP Financial furnishes the Company: (1) a written statement of RP Financial's good faith belief that it is entitled to indemnification hereunder; and (2) a written undertaking to repay the advance if it ultimately is determined in a final adjudication of such proceeding that it or he is not entitled to such indemnification. (d) In the event the Company does not pay any indemnified loss or make advance reimbursements of expenses in accordance with the terms of this agreement, RP Financial shall have all remedies available at law or in equity to enforce such obligation. This agreement constitutes the entire understanding of the Company and RP Financial concerning the subject matter addressed herein, and such contract shall be governed and construed in accordance with the laws of the Commonwealth of Virginia. This agreement may not be modified, supplemented or amended except by written agreement executed by both parties. Citizens South and RP Financial are not affiliated, and neither Citizens South nor RP Financial has an economic interest in, or is held in common with, the other and has not derived a Mr. Kim Stuart Price May 22, 2002 Page 5 significant portion of its gross revenues, receipts or net income for any period from transactions with the other. * * * * * * * * * * * Please acknowledge your agreement to the foregoing by signing as indicated below and returning to RP Financial a signed copy of this letter, together with the initial retainer fee of $5,000. Sincerely, /s/ William E. Pommerening ------------------------------------ William E. Pommerening Chief Executive Officer and Managing Director Agreed To and Accepted By: /s/ Kim S. Price ------------------------------------- Kim Stuart Price President and Chief Executive Officer Upon Authorization by the Board of Directors For: Citizens South Banking Corporation, subsidiary of Citizens South Holdings, MHC Gastonia, North Carolina Date Executed: 5/30/02 -------------- EX-99.2 14 dex992.txt EXHIBIT 99.2 EXHIBIT 99.2 Exhibit 99.2 ------------------------------------------ CONVERSION APPRAISAL REPORT CITIZENS SOUTH BANKING CORPORATION PROPOSED HOLDING COMPANY FOR CITIZENS SOUTH BANK Gastonia, North Carolina Dated As Of: June 14, 2002 ------------------------------------------ Prepared By: RP Financial, LC. 1700 North Moore Street Suite 2210 Arlington, Virginia 22209 RP FINANCIAL, LC. - ---------------------------------------------- Financial Services Industry Consultants June 14, 2002 Board of Directors Citizens South Holdings, MHC Citizens South Banking Corporation Citizens South Bank 245 West Main Avenue Gastonia, North Carolina 28053 Members of the Boards of Directors: At your request, we have completed and hereby provide an independent appraisal ("Appraisal") of the estimated pro forma market value of the common stock to be issued by Citizens South Banking Corporation, Gastonia, North Carolina ("CSBC" or the "Holding Company") in connection with the mutual-to-stock conversion of Citizens South Holdings, M.H.C. (the "MHC"). The MHC currently has a majority ownership interest in, and its principal asset consists of, approximately 58.4 percent of the common stock of CSBC (the "MHC Shares"), the mid-tier holding company for Citizens South Bank, Gastonia, North Carolina ("Citizens South" or the "Bank"). The remaining 41.6 percent of CSBC's common stock is owned by public stockholders. CSBC owns 100 percent of the outstanding common stock of Citizens South. It is our understanding that CSBC will offer its stock in a Subscription offering to the Bank's Eligible Account Holders, the ESOP, Supplemental Eligible Account Holders and Other Members. To the extent that shares remain available for purchase after satisfaction of all subscriptions received in the Subscription offering, the shares may be offered for sale in a Direct Community offering. This Appraisal is furnished pursuant to the requirements of the Code of Federal Regulations 563b.7 and has been prepared in accordance with the "Guidelines for Appraisal Reports for the Valuation of Savings and Loan Associations Converting from Mutual to Stock Form of Organization" of the Office of Thrift Supervision ("OTS"), which have been adopted in practice by the Federal Deposit Insurance Corporation ("FDIC"), including the most recent revisions as of October 21, 1994, and applicable interpretations thereof. Plan of Conversion On May 23, 2002, the respective Boards of Directors of the MHC, the Holding Company and the Bank adopted the plan of conversion pursuant to which the MHC will be merged into the Bank and the MHC will no longer exist. Pursuant to the plan of conversion, CSBC, which owns 100 percent of the Bank, will be succeeded by a new corporation with the same name. As part of the conversion, the Holding Company will sell shares of common stock in an offering that will represent the ownership interest in CSBC currently owned by the MHC. As of March 31, 2002, the MHC's ownership interest in CSBC approximated 58.4 percent. The Holding Company will - -------------------------------------------------------------------------------- Washington Headquarters Rosslyn Center Telephone.: (703) 528-1700 1700 North Moore Street, Suite 2210 Fax No.: (703) 528-1788 Arlington, VA 22209 Toll-Free No.: (866) 723-0594 www.rpfinancial.com E-Mail: mail@rpfinancial.com RP Financial, LC. Boards of Directors June 14, 2002 Page 2 also issue shares of its common stock to the public stockholders of CSBC pursuant to an exchange ratio that will result in the public shareholders owning the same aggregate percentage of the newly issued CSBC common stock as owned immediately prior to the conversion. As of March 31, 2002, the public stockholders' ownership interest in CSBC approximated 41.6 percent. RP Financial, LC. RP Financial, LC. ("RP Financial") is a financial consulting firm serving the financial services industry nationwide that, among other things, specializes in financial valuations and analyses of business enterprises and securities, including the pro forma valuation for savings institutions converting from mutual-to-stock form. The background and experience of RP Financial is detailed in Exhibit V-1. We believe that, except for the fee we will receive for our appraisal and assisting Citizens South and CSBC in the preparation of the post-conversion business plan, we are independent of the Holding Company, the Bank, the MHC and the other parties engaged by Citizens South or CSBC to assist in the stock conversion process. Valuation Methodology In preparing our Appraisal, we have reviewed the regulatory applications of CSBC, Citizens South and the MHC, including the prospectus as filed with the OTS and the Securities and Exchange Commission ("SEC"). We have conducted a financial analysis of CSBC, Citizens South and the MHC that has included a review of audited financial information for the past five fiscal years through 2001 and interim financial results through March 31, 2002, a review of various unaudited information and internal financial reports through March 31, 2002, and due diligence related discussions with CSBC's management; Cherry, Bekaert & Holland, L.L.P., CSBC's independent auditor; Luse Gorman Pomerenk & Schick, P.C., CSBC's conversion counsel; and Keefe, Bruyette & Woods Inc., CSBC's marketing advisor in connection with the stock offering. All assumptions and conclusions set forth in the Appraisal were reached independently from such discussions. In addition, where appropriate, we have considered information based on other available published sources that we believe are reliable. While we believe the information and data gathered from all these sources are reliable, we cannot guarantee the accuracy and completeness of such information. We have investigated the competitive environment within which CSBC operates and have assessed CSBC's relative strengths and weaknesses. We have kept abreast of the changing regulatory and legislative environment for financial institutions and analyzed the potential impact on CSBC and the industry as a whole. We have analyzed the potential effects of the stock conversion on CSBC's operating characteristics and financial performance as they relate to the pro forma market value of CSBC. We have analyzed the assets held by the MHC, which will be consolidated with the Bank's assets and equity pursuant to the completion of conversion. We have reviewed the overall conditions in CSBC's primary market area as set forth in RP Financial, LC. Boards of Directors June 14, 2002 Page 3 demographic, economic and competitive information prepared by CACI, SNL Financial and other third party private and governmental sources. We have compared CSBC's financial performance and condition with selected publicly-traded thrifts in accordance with the Valuation Guidelines, as well as all publicly-traded thrifts and thrift holding companies. We have reviewed the current conditions in the securities markets in general and in the market for thrift stocks in particular, including the market for existing thrift issues, initial public offerings by thrifts and thrift holding companies, and second step conversion offerings. We have excluded from such analyses thrifts subject to announced or rumored acquisition, and/or institutions that exhibit other unusual characteristics. The Appraisal is based on CSBC's representation that the information contained in the regulatory applications and additional information furnished to us by CSBC and their respective independent auditors, legal counsel and other authorized agents are truthful, accurate and complete. We did not independently verify the financial statements and other information provided by CSBC, or their respective independent auditors, legal counsel and other authorized agents nor did we independently value the assets or liabilities of CSBC. The valuation considers CSBC only as a going concern and should not be considered as an indication of CSBC's liquidation value. Our appraised value is predicated on a continuation of the current operating environment for CSBC and for all thrifts and their holding companies. Changes in the local, state and national economy, the legislative and regulatory environment for financial institutions and mutual holding companies, the stock market, interest rates, and other external forces (such as natural disasters or significant world events) may occur from time to time, often with great unpredictability and may materially impact the value of thrift stocks as a whole or the value of CSBC's stock alone. It is our understanding that there are no current plans for selling control of CSBC following completion of the second step stock offering. To the extent that such factors can be foreseen, they have been factored into our analysis. The estimated pro forma market value is defined as the price at which CSBC's common stock, immediately upon completion of the second step stock offering, would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. Valuation Conclusion It is our opinion that, as of June 14, 2002, the estimated aggregate pro forma valuation of the shares to be issued in the conversion of the MHC, including: (1) newly-issued shares representing the MHC's ownership interest in CSBC and (2) exchange shares issued to existing public shareholders of CSBC was $68,529,460 at the midpoint, equal to 6,852,946 shares at a per share value of $10.00. Based on this valuation and taking into account the ownership interest represented by the shares owned by the MHC, the midpoint of the offering range was $40,000,000, equal to 4,000,000 shares at $10.00 per share. The offering range includes a RP Financial, LC. Boards of Directors June 14, 2002 Page 4 minimum value of $34,000,000, equal to 3,400,000 shares at $10.00 per share (85.0 percent of the midpoint) and a maximum value of $46,000,000, equal to 4,600,000 shares at $10.00 per share (115.0 percent of the midpoint). In the event the appraised value is subject to an increase, the offering range may be increased up to a supermaximum value of $52,900,000, equal to 5,290,000 shares at $10.00 per share, without requiring a resolicitation. Establishment of the Exchange Ratio OTS regulations provide that in a conversion of a mutual holding company, the minority stockholders are entitled to exchange the public shares for newly issued shares of CSBC stock as a fully converted company. The Board of Directors of the MHC has independently established a formula to determine the exchange ratio. The formula has been designed to preserve the current aggregate percentage ownership in CSBC equal to 41.63 percent as of March 31, 2002. Pursuant to this formula, the exchange ratio to be received by the existing minority shareholders of CSBC will be determined at the end of the offering, based on the total number of shares sold in the Subscription and Direct Community offerings. Based upon this formula, and the valuation conclusion and offering range concluded above, the exchange ratio would be 1.3838 shares, 1.6280 shares, 1.8722 shares and 2.1530 shares of newly issued shares of CSBC stock for each share of stock held by the public shareholders at the minimum, midpoint, maximum and supermaximum of the offering range, respectively. RP Financial expresses no opinion on the proposed exchange of newly issued Holding Company shares for the shares held by the public stockholders or on the proposed exchange ratio. Limiting Factors and Considerations Our valuation is not intended, and must not be construed, as a recommendation of any kind as to the advisability of purchasing shares of the common stock. Moreover, because such valuation is necessarily based upon estimates and projections of a number of matters, all of which are subject to change from time to time, no assurance can be given that persons who purchase shares of common stock in the conversion will thereafter be able to buy or sell such shares at prices related to the foregoing valuation of the estimated pro forma market value thereof. The appraisal does not take into account any trading activity with respect to the purchase and sale of common stock in the secondary market, and reflects only a valuation range as of this date for the pro forma market value of CSBC immediately upon issuance of the stock. RP Financial's valuation was determined based on the financial condition, operations and shares outstanding of CSBC as of March 31, 2002, the date of the financial data included in the prospectus. The proposed exchange ratio to be received by the current public stockholders of CSBC and the exchange of the public shares for newly issued shares of CSBC common stock as a full public company was determined independently by the Boards of Directors of the MHC. RP Financial expresses no opinion on the proposed exchange ratio to public stockholders or the exchange of public shares for newly issued shares. RP Financial, LC. Boards of Directors June 14, 2002 Page 5 RP Financial is not a seller of securities within the meaning of any federal and state securities laws and any report prepared by RP Financial shall not be used as an offer or solicitation with respect to the purchase or sale of any securities. RP Financial maintains a policy which prohibits RP Financial, its principals or employees from purchasing stock of its client institutions. This valuation will be updated as provided for in the conversion regulations and guidelines. These updates will consider, among other things, any developments or changes in the financial performance and condition of CSBC, management policies, and current conditions in the equity markets for thrift shares, both existing issues and new issues. These updates may also consider changes in other external factors which impact value including, but not limited to: various changes in the legislative and regulatory environment for financial institutions, the stock market and the market for thrift stocks, and interest rates. Should any such new developments or changes be material, in our opinion, to the valuation of the shares, appropriate adjustments to the estimated pro forma market value will be made. The reasons for any such adjustments will be explained in the update at the date of the release of the update. The valuation will also be updated at the completion of CSBC's stock offering. Respectfully submitted, RP FINANCIAL, LC. /s/ William E. Pommerening William E. Pommerening Chief Executive Officer /s/ Gregory E. Dunn Gregory E. Dunn Senior Vice President RP Financial, LC. TABLE OF CONTENTS CITIZENS SOUTH BANKING CORPORATION Gastonia, North Carolina
PAGE DESCRIPTION NUMBER ----------- ------ CHAPTER ONE OVERVIEW AND FINANCIAL ANALYSIS ----------- Introduction 1.1 Plan of Conversion 1.2 Strategic Overview 1.2 Balance Sheet Trends 1.6 Income and Expense Trends 1.10 Interest Rate Risk Management 1.15 Lending Activities and Strategy 1.16 Asset Quality 1.19 Funding Composition and Strategy 1.20 Subsidiary 1.21 Legal Proceedings 1.21 CHAPTER TWO MARKET AREA ----------- Introduction 2.1 Market Area Demographics 2.2 National Economic Factors 2.4 Local Economy 2.7 Market Area Deposit Characteristics and Competition 2.8 CHAPTER THREE PEER GROUP ANALYSIS ------------- Peer Group Selection 3.1 Financial Condition 3.5 Income and Expense Components 3.9 Loan Composition 3.12 Interest Rate Risk 3.15 Credit Risk 3.15 Summary 3.17
RP Financial, LC. TABLE OF CONTENTS CITIZENS SOUTH BANKING CORPORATION Gastonia, North Carolina (continued)
PAGE DESCRIPTION NUMBER ----------- ------ CHAPTER FOUR VALUATION ANALYSIS ------------ Introduction 4.1 Appraisal Guidelines 4.1 RP Financial Approach to the Valuation 4.1 Valuation Analysis 4.2 1. Financial Condition 4.3 2. Profitability, Growth and Viability of Earnings 4.5 3. Asset Growth 4.7 4. Primary Market Area 4.7 5. Dividends 4.9 6. Liquidity of the Shares 4.10 7. Marketing of the Issue 4.11 A. The Public Market 4.11 B. The New Issue Market 4.17 C. The Acquisition Market 4.19 D. Trading in CSBC's Stock 4.21 8. Management 4.22 9. Effect of Government Regulation and Regulatory Reform 4.22 Summary of Adjustments 4.22 Valuation Approaches 4.23 1. Price-to-Earnings ("P/E") 4.25 2. Price-to-Book ("P/B") 4.27 3. Price-to-Assets ("P/A") 4.27 Comparison to Recent Conversions and Second-Step Offerings 4.27 Valuation Conclusion 4.28 Establishment of the Exchange Ratio 4.29
RP Financial, LC. LIST OF TABLES CITIZENS SOUTH BANKING CORPORATION Gastonia, North Carolina
TABLE NUMBER DESCRIPTION PAGE - ------ ----------- ---- 1.1 Historical Balance Sheets 1.7 1.2 Historical Income Statements 1.11 2.1 Summary Demographic Information 2.3 2.2 Unemployment Trends 2.8 2.3 Deposit Summary 2.9 3.1 Peer Group of Publicly-Traded Thrifts 3.3 3.2 Balance Sheet Composition and Growth Rates 3.6 3.3 Income as a Percent of Average Assets and Yields, Costs, Spreads 3.10 3.4 Loan Portfolio Composition Comparative Analysis 3.13 3.5 Interest Rate Risk Measures and Net Interest Income Volatility 3.16 3.6 Credit Risk Measures and Related Information 3.18 4.1 Market Area Unemployment Rates 4.9 4.2 Pricing Characteristics and After Market Trends Recent Conversions 4.18 4.3 Market Pricing Comparatives 4.20 4.4 Public Market Pricing 4.26
RP Financial, LC. Page 1.1 I. OVERVIEW AND FINANCIAL ANALYSIS Introduction Citizens South Bank ("Citizens South" or the "Bank"), chartered in 1904, is a federally-chartered stock savings bank headquartered in Gastonia, North Carolina. The Bank changed its name from Gaston Federal Bank to its current name in March 2002, following the acquisition of Innes Street Financial Corporation ("Innes Street") and its wholly-owned subsidiary, Citizens Bank, Inc. The acquisition of Innes Street became effective on December 31, 2001. The Bank maintains its main office and five branch offices in Gaston County, North Carolina, which is located in the I-85 corridor, approximately twenty miles west of the regional banking center of Charlotte, North Carolina. The Bank also operates two branch offices in Rowan County, North Carolina, and one branch office in Iredell County, North Carolina. These offices are located approximately 60 miles northeast of the main office. A map of the Bank's office locations is included as Exhibit I-1. Citizens South is a member of the Federal Home Loan Bank ("FHLB") system and its deposits are insured up to the maximum allowable amount by the Federal Deposit Insurance Corporation ("FDIC"). Citizens South Banking Corporation ("CSBC" or the "Holding Company") is a federally-chartered stock holding company that was organized in March 1998 as Gaston Federal Bancorp, Inc. for the purpose of acquiring all of the capital of the Bank upon completion of the Bank's reorganization from a mutual savings bank into a mutual holding company structure. In May 2002, the shareholders of the Holding Company approved an amendment to change the name to Citizens South Banking Corporation and the parent mutual holding company, which was originally organized as Gaston Federal Holdings, MHC, is now Citizens South Holdings, MHC (the "MHC"). As part of the reorganization, the Holding Company offered for sale 47.0 percent of the shares of its common stock in a public offering. The remaining 53.0 percent of the Holding Company's shares of common stock were issued to the MHC. The reorganization and public stock offering were completed on April 9, 1998. Net proceeds from the public stock offering amounted to $18.5 million. As of March 31, 2002, the MHC owned 2,457,007 shares or 58.4 percent of the Holding Company's shares of common stock outstanding and the public owned the remaining 1,752,427 shares or 41.6 percent of the Holding Company's shares of RP Financial, LC. Page 1.2 common stock outstanding. As of March 31, 2002, CSBC had $443.3 million in assets, $352.1 million in deposits and total equity of $42.2 million or 9.5 percent of total assets. CSBC's audited financial statements are included by reference as Exhibit I-2. Plan of Conversion On May 23, 2002, the respective Boards of Directors of the MHC, the Holding Company and the Bank adopted the plan of conversion pursuant to which the MHC will be merged into the Bank and the MHC will no longer exist. Pursuant to the plan of conversion, CSBC, which owns 100 percent of the Bank, will be succeeded by a new corporation with the same name. As part of the conversion, the Holding Company will sell shares of common stock in an offering that will represent the ownership interest in CSBC currently owned by the MHC. As of March 31, 2002, the MHC's ownership interest in CSBC approximated 58.4 percent. The Holding Company will also issue shares of its common stock to the public stockholders of CSBC pursuant to an exchange ratio that will result in the public shareholders owning the same aggregate percentage of the newly issued CSBC common stock as owned immediately prior to the conversion. As of March 31, 2002, the public stockholders' ownership interest in CSBC approximated 41.6 percent. Strategic Overview CSBC maintains a local community banking emphasis, with a primary strategic objective of meeting the borrowing and savings needs of its local customer base. On December 31, 2001, the Holding Company completed the cash acquisition of Innes Street and its wholly-owned subsidiary, Citizens Bank. The $37.9 million cash acquisition of Innes Street significantly increased the Holding Company's asset size, leveraged capital and tangible capital, and expanded the branch network outside of Gaston County. Citizens Bank operated a main office and one branch office in Rowan County and one branch office in Iredell County. At the time of the acquisition, Innes Street had total assets of $221.8 million, net loans of $170.5 million, total deposits of $175.4 million and total liabilities of $183.8 million. The acquisition was accounted for using the purchase method of accounting, creating $9.5 million of intangible assets. RP Financial, LC. Page 1.3 Historically, CSBC's operating strategy has been fairly reflective of a traditional thrift operating strategy in which 1-4 family residential mortgage loans and retail deposits have constituted the principal components of the Holding Company's assets and liabilities, respectively. Innes Street's operating strategy also emphasized 1-4 family lending funded by retail deposits. In recent years, the Holding Company has pursued a more diversified lending strategy, emphasizing growth of commercial business and consumer loans. On a more limited basis, the Holding Company's lending activities include diversification into construction, land, commercial real estate and multi-family loans. In 2001, the Holding Company utilized the lower interest rate environment as an opportunity to accelerate diversification of the loan portfolio, through reinvesting increased prepayments of residential mortgages caused by the high demand for the refinancing of such loans into commercial business and home equity loans. CSBC's implementation of a more diversified lending strategy is expected to enhance the yield and interest rate sensitivity of the loan portfolio, while also increasing the credit risk associated with the loan portfolio. The Holding Company has sought to limit the credit risk exposure associated with higher risk types of loans, through emphasizing origination of such loans in local markets and to established lending relationships with favorable credit histories. To date, the Holding Company's more diversified lending strategy has not led to a deterioration in credit quality, although non-performing assets increased as the result of acquisition of Innes Street. Most notably, the Holding Company acquired an office building property that is currently held as real estate owned with a carrying value of $1.3 million. The office building is located in Greenville, South Carolina, and is listed for sale with an independent real estate sales agent. Notwithstanding the increase in problem assets that resulted from the acquisition of Innes Street, the Holding Company's ratio of non-performing assets to total assets remains favorably low. Investments serve as a supplement to the Holding Company's lending activities. The Holding Company's investment strategy emphasizes low risk types of investments, with the intent of providing and maintaining liquidity and to generate a favorable return within the context of supporting interest rate and credit risk objectives. Investments currently held by the Holding Company consist primarily of mortgage-backed securities and U.S. Government and agency securities. To manage the interest rate risk associated with the investment portfolio, the RP Financial, LC. Page 1.4 Holding Company has emphasized investing in securities that mature or reprice in five years or less and all investment securities are maintained as available for sale. Retail deposits have consistently served as the primary interest-bearing funding source for the Holding Company and the Holding Company has sustained positive deposit growth over the past three and one-half years, with the most significant growth provided by the acquisition of Innes Street's deposits in 2001. CSBC experienced a slight decline in deposits in the first quarter of 2002, reflecting some minor deposit run-off in the branches that were acquired. The Holding Company's deposit composition was not significantly altered by the deposits acquired from Innes Street, with CDs continuing to comprise approximately two-thirds of total deposits. Borrowings serve as an alternative funding source for the Holding Company to support management of funding costs and to manage interest rate risk. The Holding Company's use of borrowings has emphasized FHLB advances with fixed rate terms of less than ten years, some of which have a one-time call provision. The Holding Company also holds a modest balance of other short-term borrowings. CSBC's earnings base is largely dependent upon net interest income and operating expense levels, although sources of non-interest operating have become a more significant earnings contributor in recent years. The Holding Company has experienced a downward trend in the net interest margin during recent years, reflecting interest rate spread compression attributable to the decline in yield earned on interest-earning assets. The Holding Company's interest rate spread increased significantly in the first quarter of 2002, which was realized through a steeper decline in funding costs relative to the decline in yield earned on interest-earning assets. However, the improvement in net interest income was less significant, as the acquisition of Innes Street resulted in increases in the Holding Company's level of non-interest earning assets-to-assets and level of interest-bearing liabilities-to-assets. Accordingly, the increase in net interest income provided by the widening yield-cost spread was somewhat offset by a sharp decline in the Holding Company's interest-earning assets-to-interest-bearing liabilities ("IEA/IBL") ratio. Growth of non-interest operating income has been primarily realized through increased fee income on deposit accounts, which has been supported by implementation of an aggressive marketing program to increase fee generating deposit accounts. The opening of new RP Financial, LC. Page 1.5 branch offices in 2000 and 2001, as well as implementation of a competitive fee structure on deposit products has also contributed to the increase in fee income earned on deposit accounts. Operating expenses represent the other major component of the Holding Company's earnings and have exhibited a notable increase in recent years. Higher operating expenses have resulted from adding two new branches during the past two years, prior to taking into account the three branches added from the acquisition of Innes Street, and the additional expense associated with the servicing a larger number of transaction deposit accounts. Given that the two branch openings have been fairly recent, the costs of operating and maintaining the two branches have yet to be fully leveraged. The acquisition of Innes Street will further increase the Holding Company's operating expenses, but should support a decline in the operating expense ratio as a percent of average assets. The lower operating expense ratio will be supported by cost savings realized in the merger and Innes Street's lower cost of operations. Over the past five and one-half years, CSBC's operating strategy has resulted in significant asset growth, leveraging of capital and gradual transformation of the balance sheet to a more "bank like" structure. A key component of the Holding Company's business plan is to complete a second step conversion offering. In particular, the additional equity capital raised in the conversion will provide a larger capital cushion for asset growth, including possible growth through other acquisitions of local thrifts, commercial banks or other financial service providers as opportunities arise. As a fully-converted institution, it is contemplated that the ability to offer Holding Company stock as consideration will facilitate increased opportunities to grow through acquisition. The Holding Company anticipates that growth opportunities will also result from the expansion of market area provided by the acquisition of Innes Street, as well as further expanding the branch network through establishing additional branches that complement the existing branch network. Additionally, CSBC's higher capital position resulting from the infusion of conversion proceeds will also serve to reduce interest rate risk, through enhancing the Holding Company's IEA/IBL ratio. The additional funds realized from the stock offering will provide an alternative funding source to deposits and borrowings in meeting the Holding Company's future funding needs, which may facilitate a reduction in CSBC's funding costs. RP Financial, LC. Page 1.6 . CSBC. The Holding Company is expected to retain up to 50 percent of the net conversion proceeds. At present, funds at the Holding Company level, net of the loan to the ESOP, are expected to be initially invested primarily into short-term investment grade securities. Over time, the funds may be utilized for various corporate purposes, which may include acquisitions, infusing additional equity into the Bank, repurchases of common stock, and the payment of regular and/or special cash dividends. . Citizens South. Approximately 50 percent of the net conversion proceeds will be infused into the Bank. Cash proceeds (i.e., net proceeds less deposits withdrawn to fund stock purchases) infused into the Bank will initially become part of general funds, pending deployment into loans. Balance Sheet Trends Table 1.1 presents the Holding Company's balance sheet trends from September 30, 1997 through March 31, 2002. The Holding Company switched from a September 30 fiscal year to a calendar fiscal year in 2000. From September 30, 1997 through March 31, 2002, CSBC exhibited average annual asset growth of 23.2 percent, with the strongest growth occurring in 2001 as the result of the acquisition of Innes Street. Asset growth has been primarily realized through loan growth, while growth in investment securities and mortgage-backed securities have been more limited. Overall, total interest-earning assets comprising total assets has declined since September 30, 1997, primarily as the result of the goodwill and intangibles created by the acquisition of Innes Street. As of March 31, 2002, goodwill and intangibles equaled 2.0 percent of total assets. Asset growth has been funded by a combination of deposits, borrowings and capital, with trends in the Holding Company's funding composition showing an increase in the level of borrowings funding assets and declines in the level of deposits and capital funding assets. A summary of CSBC's key operating ratios for the past five fiscal years and the first quarter of fiscal 2002 is presented in Exhibit I-3. Prior to the acquisition of Innes Street, growth of the loan portfolio was somewhat limited. Net loans receivable declined from 77.5 percent of assets at September 30, 1997 to 62.8 percent of assets at December 31, 2000. The acquisition of Innes Street supported an increase in the loans-to-assets ratio to 74.7 percent at year end 2001, with the ratio declining to 73.0 percent at the end of the first quarter of 2002 due to a decline in net loans receivable. The decline in loans receivable in the first quarter of 2002, as well as in 2000, was mostly attributable to a RP Financial, LC. Page 1.7 (table omitted) RP Financial, LC. Page 1.8 decline in the balance of 1-4 family permanent mortgage loans, reflecting the impact of accelerated repayments of 1-4 loans caused by borrowers refinancing into lower rate loans, the Holding Company's philosophy of closing originations of 1-4 family fixed rate loans in a third party name and the sale of fixed rate loans in 2000. Trends in the Holding Company's loan portfolio composition highlight the current business plan of a pursuing a more diversified lending strategy, particularly emphasizing consumer and commercial business types of lending. Over the past five and one-half years, the concentration of 1-4 family permanent mortgage loans comprising total loans declined from 76.5 percent at September 30, 1997 to 56.3 percent at March 31, 2002. Comparatively, over the same time period, consumer loans increased from 5.3 percent to 19.7 percent of total loans and commercial business loans increased from 4.0 percent to 9.4 percent of total loans. Loan growth realized from the acquisition of Innes Street consisted mostly of 1-4 family permanent mortgage loans, consumer loans and commercial real estate/multi-family/land loans. As of March 31, 2002, commercial real estate/multi-family/land loans equaled 9.9 percent of total loans outstanding, with the balance of the portfolio consisting of construction loans (4.7 percent of total loans outstanding). The intent of the Holding Company's investment policy is to provide adequate liquidity and to generate a favorable return within the context of supporting CSBC's overall credit and interest rate risk objectives. It is anticipated that proceeds retained at the holding company level will primarily be invested into investments with short-term maturities. Over the past five and one-half years, the Holding Company's level of cash and investment securities (inclusive of FHLB stock) ranged from a low of 11.4 percent of assets at year end 2001 to a high of 24.8 percent of assets at September 30, 1998. As of March 31, 2002, the Holding Company maintained total cash and investments of $62.5 million or 14.2 percent of assets, which mostly consisted of $36.2 million of cash and equivalents. Investments held by the Holding Company at March 31, 2002 consisted of U.S. Government and agency securities ($11.1 million), municipal bonds ($6.2 million), corporate bonds ($2.1 million), equity securities ($3.5 million) and FHLB stock $3.4 million. The investment portfolio is classified as available for sale and, as of March 31, 2002, the Holding Company maintained a net unrealized gain of $1.4 million on the investment portfolio. Exhibit I-4 provides detail of the Holding Company's investment portfolio. RP Financial, LC. Page 1.9 Mortgage-backed securities comprise the balance of the Holding Company's interest-earning assets composition, serving as an investment alternative to deploy excess liquidity. The mortgage-backed securities portfolio consists of securities guaranteed or insured by a federal agency and includes a mixture of fixed rate and adjustable rate securities. The mortgage-backed securities portfolio ranged from a high of 9.1 percent of assets at year end 2000 to a low of 5.2 percent of assets at March 31, 2002. As of March 31, 2002, the mortgage-backed securities portfolio totaled $23.0 million and was classified as available for sale. A net unrealized loss of $52,000 was maintained on the mortgage-backed securities portfolio at March 31, 2002. The Bank also maintains an investment in bank-owned life insurance ("BOLI") policies, which cover the lives of some of the Bank's executive officers and directors. Citizens South is the owner and beneficiary of the policies and the purpose of the investment is to provide funding for the Bank's employee benefit plans. The life insurance policies earn tax-exempt income through cash value accumulation and death proceeds. As of March 31, 2002, the cash surrender value of the BOLI equaled $6.6 million. Over the past five and one-half years, CSBC's funding needs have been substantially met through retail deposits, internal cash flows, borrowings and retained earnings. From September 30, 1997 through March 31, 2002, deposits increased at an average annual rate of 21.7 percent. The substantial portion of the Holding Company's deposit growth was realized through the acquisition of Innes Street in 2001, which also supported an increase in the deposits-to-assets ratio from 66.4 percent at year end 2000 to 79.0 percent at year end 2001. In recent years, the Holding Company's deposit composition has exhibited a shift towards a slightly higher concentration of CDs, which was primarily attributable to the relatively high concentration of CDs that comprised Innes Street's deposit composition. As of March 31, 2002, CDs and transaction and savings accounts represented 68.0 percent and 32.0 percent of the Holding Company's total deposits, respectively, versus comparable ratios of 64.9 percent and 35.1 percent at September 30, 1999. Borrowings serve as an alternative funding source for the Holding Company to support management of funding costs and interest rate risk. Utilization of borrowings consists primarily of FHLB advances, most of which were added following the minority stock offering in 1998 to RP Financial, LC. Page 1.10 facilitate leveraging of capital. Over the past five and one-half years, borrowings ranged from a low of 2.0 percent of assets at September 30, 1997 to a high of 16.9 percent of assets at year end 2000. As of March 31, 2002, borrowings totaled $41.0 million or 9.5 percent of assets, consisting of $39.0 million of FHLB advances and $2.0 million of other short-term borrowings. FHLB advances held by the Holding Company consist of fixed rate notes for terms of less than 10 years, some of which have a one-time call provision. Since September 30 1997 through March 31, 2002, retained earnings and net proceeds realized from the minority stock offering translated into an average annual capital growth rate of 17.0 percent for the Holding Company. The most significant capital growth was recorded in 1998, as the result of the completion of the minority stock offering. Net proceeds from the minority stock offering amounted to $18.5 million, which supported an increase in the Holding Company's equity-to-assets ratio from 12.0 percent at September 30, 1997 to 20.0 percent at September 30, 1998. Since 1998, capital growth has been slowed by dividend payments and stock repurchases, which combined with asset growth, has served to leverage the Holding Company's equity-to-assets ratio down to 9.5 percent at March 31, 2002. The most significant asset growth and leveraging of capital was provided by the acquisition of Innes Street completed effective December 31, 2001. As the result of the goodwill and intangibles created by the acquisition, the decline in the Holding Company's tangible equity-to-assets ratio has been more significant. The Holding Company's tangible equity-to-assets ratio equaled 7.6 percent at March 31, 2002, versus a comparable ratio of 20.0 percent at September 30, 1998. The additional capital realized from the second step conversion offering will serve to strengthen the Holding Company's capital position and support the growth strategies contemplated in its business plan. Income and Expense Trends Table 1.2 shows the Holding Company's historical income statements from twelve months ended September 30, 1997 through the twelve months ended March 31, 2002. The Holding Company reported positive earnings over the past five fiscal years and for the most recent twelve month period, ranging from a low of 0.65 percent of average assets during the twelve months ended March 31, 2002 to a high of 0.98 percent of average assets during the twelve months ended September 30, 1998. The lower return on assets ratio indicated for the RP Financial, LC. Page 1.11 (table omitted) RP Financial, LC. Page 1.12 most recent twelve month period is in part attributable to the impact on average assets and earnings resulting from the acquisition of Innes Street. The average assets balance for the twelve months ended March 31, 2002 was calculated based on the average of the quarter end balances for the past five quarters. Accordingly, since the acquisition of Innes Street was completed effective December 31, 2001, the average includes two quarters with the increase in assets realized from the acquisition of Innes Street. Comparatively, the earnings for the twelve months ended March 31, 2002 includes only one quarter of higher earnings that was provided by the acquisition of Innes Street. Net interest income and operating expenses represent the primary components of the Holding Company's earnings, while non-interest operating income has been a growing contributor to the Holding Company's earnings. The Holding Company's historically strong credit quality has generally served to limit the impact of loss provisions on earnings. Gains and losses realized from the sale of securities and other assets have had a varied impact on earnings over the past five and one-half years and are not considered to be part of the Holding Company's recurring or core earnings. Over the past five and one-half years, the Holding Company's net interest income to average assets ratio has ranged from a low of 2.52 percent for the year ended December 31, 2001 to a high of 3.53 percent for the twelve months ended September 30, 1998. The general decline in the net interest income ratio since 1998 reflects the impact of interest rate spread compression, as CSBC experienced a more significant decline in the average yield earned on interest-earning assets compared to the average cost paid for interest-bearing liabilities. Accordingly, the Holding Company's interest rate spread declined from 3.16 percent during the twelve months ended September 30, 1998 to 2.05 percent for the year ended December 31, 2001. The decline in the net interest income ratio also reflects the impact of a declining IEA/IBL ratio, as the acquisition of Innes Street resulted in a reduction in the level of interest-earning assets comprising assets and an increase in the level of interest-bearing liabilities funding assets. Accordingly, while the Holding Company's interest rate spread increased to 3.50 percent in the first quarter of 2002, due to a shaper decline in funding costs compared to the decline in yield earned on interest-earning assets, the increase in net interest income to average assets ratio provided by the widening yield-cost spread was somewhat offset by the reduction experienced in RP Financial, LC. Page 1.13 the IEA/IBL ratio. The Holding Company's historical net interest rate spreads, yields and costs and IEA/IBL ratios are set forth in Exhibits I-3 and I-5. Non-interest operating income has been a growing contributor to the Holding Company's earnings, increasing from 0.27 percent of average assets for the twelve months ended September 30, 1997 to a high of 1.15 percent of average assets for the year ended December 31, 2001. For the twelve months ended March 31, 2002, non-interest operating income equaled 0.98 percent of average assets. Growth of non-interest operating income has been primarily realized through increased fee income on deposit accounts, which has been supported by implementation of an aggressive marketing program to increase fee generating deposit accounts. The opening of new branch offices in 2000 and 2001, as well as implementation of a competitive fee structure on deposit products has also contributed to the increase in fee income earned on deposit accounts. To a lesser extent, growth in non-interest operating income has been supported by increased loan fee income realized from increased originations of 1-4 family fixed rate loans and an increase in income generated by additional purchases of BOLI. Operating expenses represent the other major component of the Holding Company's earnings, ranging from a low of 2.32 percent of average assets for the twelve months ended September 30, 1997 to a high of 2.78 percent of average assets for the twelve months ended September 30, 1999. The Holding Company's operating expense to average assets ratio equaled 2.55 percent for the twelve months ended March 31, 2002. The upward trend in operating expenses reflects the impact of adding two new branches during the past two years, prior to taking into account the three branches added from the acquisition of Innes Street, and the additional expense associated with the servicing a larger number of transaction deposit accounts. Given that the two branch openings have been fairly recent, the costs of operating and maintaining the two branches have yet to be fully leveraged. The acquisition of Innes Street will further increase the Holding Company's operating expenses, but should support a decline in the operating expense ratio as a percent of average assets due to cost savings realized in the merger and Innes Street's lower cost of operations. At the same time upward pressure will be placed on the Holding Company's operating expense ratio following the stock offering, due to expenses associated with operating as a company that is 100 percent owned by public shareholders and expenses related to the implementation of the stock benefit plans. However, the increase in RP Financial, LC. Page 1.14 capital realized from the stock offering will also increase the Holding Company's capacity to leverage operating expenses through further growth of the balance sheet. Overall, the general trends in the Holding Company's net interest margin and operating expense ratio since 1997 reflect a decline in the Holding Company's core earnings, as indicated by the expense coverage ratio (net interest income divided by operating expenses). CSBC's expense coverage ratio equaled 1.51 times for the twelve months ended September 30, 1997, versus a comparable ratio of 0.99 times during the twelve months ended March 31, 2002. The decline in the expense coverage resulted from a decline in the net interest income ratio and an increase in the operating expense ratio. Similarly, CSBC's efficiency ratio (operating expenses, net of amortization of intangibles, as a percent of the sum of net interest income and other operating income) of 69.5 percent for twelve months ended March 31, 2002 was less favorable than the 61.4 percent efficiency ratio maintained for the twelve months ended September 30, 1997. Reinvestment of the net conversion proceeds, as well as realizing the increase in core earnings provided by Innes Street acquisition for a full twelve month period should facilitate improvement in the Holding Company's expense coverage and efficiency ratios going forward. Loan loss provisions have generally had a limited impact on the Holding Company's earnings over the past five and one-half years, which has been supported by the Holding Company's favorable credit quality. Loan loss provisions established by the Holding Company declined from a high of 0.17 percent of average assets for the twelve months ended September 30, 1997 to a low of 0.02 percent of average assets for the twelve months ended December 31, 2000. For the twelve months ended March 31, 2002, loss provisions established by CSBC equaled 0.05 percent of average assets. As of March 31, 2002, the Holding Company maintained allowance for loan losses of $3.0 million, equal to 95.9 percent of non-performing assets and 0.93 percent of net loans receivable. Exhibit I-6 sets forth the Holding Company's allowance for loan loss activity during the past five and one-half years. Net gains and loss resulting from the sale of investment securities and other assets have generally been a limited factor in the Holding Company's earnings. For the twelve months ended March 31, 2002, net gains equaled 0.03 percent of average assets. The relatively high net gains recorded in 1999, equal to 0.62 percent of average assets, was primarily realized through a $1.3 million gain recorded on the sale of $6.4 million of investments, while the net loss recorded RP Financial, LC. Page 1.15 in 2000, equal to 0.24 percent of average assets, primarily resulted from the sale of $18.2 million of loans at a loss of $873,000. The loans were primarily long-term, fixed rate mortgages and were sold in order to reduce the Holding Company's exposure to rising interest rates. The proceeds from the loan sale were primarily used to fund the origination of shorter-term non-residential loans and adjustable rate home equity lines of credit. Overall, the gains and losses recorded by the Holding Company are not considered to be part of its recurring or core earnings. Interest Rate Risk Management The Holding Company pursues a number of strategies to manage interest rate risk, which have been fairly effective in limiting the repricing mismatch between interest rate sensitive assets and liabilities. Management of the Holding Company's interest rate risk is conducted on an ongoing basis and is reviewed formally by the Asset/Liability Committee ("ALCO") quarterly. The Holding utilizes reports prepared by Risk Analytics, an independent third party, and the OTS to monitor and analyze the effects that interest rate movements will have on the balance sheet and on net interest income. The Risk Analytics analysis, as of March 31, 2002, indicated a 200 basis point instantaneous and sustained rise in interest rates would result in an 18.8 percent decline in the Bank's Net Portfolio Value (see Exhibit I-7). This is within targeted limits as set forth by the Board. The Holding Company manages interest rate risk from the asset side of the balance sheet, through such strategies as maintaining investments as available-for-sale, investing in securities with short-terms or floating rates, closing originations of 1-4 family fixed rate loans in a third party name and emphasizing the origination and retention of adjustable rate loans and short-term fixed rate loans. As of March 31, 2002, of the total loans due after December 31, 2002, ARM loans comprised 52.4 percent of those loans (see Exhibit I-8). On the liability side of the balance sheet, management of interest rate risk has been pursued through utilizing fixed rate FHLB advances with terms of more than one year and emphasizing growth of less interest rate sensitive and lower cost core deposits in the form of savings and transaction accounts. The infusion of stock proceeds will serve to further limit the Holding Company's interest rate risk exposure, as most of the net proceeds will be redeployed into interest-earning assets and RP Financial, LC. Page 1.16 the increase to capital will lessen the proportion of interest rate sensitive liabilities funding assets. Lending Activities and Strategy CSBC's lending activities have traditionally emphasized 1-4 family permanent mortgage loans and 1-4 family permanent mortgage loans still comprise the largest concentration of the loan portfolio. The Holding Company's current lending activities have emphasized originating commercial business loans, consumer loans, home equity lines of credit, as well as 1-4 family permanent mortgage loans. To a lesser extent, lending diversification by the Holding Company includes construction, commercial real estate and multi-family loans. Exhibit I-9 provides historical detail of CSBC's loan portfolio composition over the past five and one-half years and Exhibit I-10 provides the contractual maturity of the Holding Company's loan portfolio by loan type as of December 31, 2001. CSBC originates both fixed rate and adjustable rate 1-4 family permanent mortgage loans, generally retaining ARM loan originations for investment. Fixed rate loan originations are generally closed in a third party name and are not retained in the Holding Company's loan portfolio. Fixed rate loans offered by the Holding Company have terms ranging from 10 to 30 years. CSBC offers ARM loans that have an initial fixed interest rate for three or five years and then convert to a one-year ARM following the initial repricing period. ARM loans are based on the Treasury constant maturity index, with the initial rate of interest dependent upon the length of the repricing term (i.e., generally a higher rate is charged for loans with a longer initial repricing term). CSBC originates 1-4 family loans up to a loan-to-value ("LTV") of 95.0 percent, with private mortgage insurance required for loans with LTV ratios greater than 80.0 percent. As of March 31, 2002, the Holding Company's 1-4 family permanent mortgage loan portfolio totaled $187.1 million or 56.3 percent of total loans outstanding. Construction loans originated by the Holding Company consist of loans to finance the construction of 1-4 family residences. The Holding Company's construction lending activities include financing to builders for the construction of homes that are built on both a speculative and pre-sold basis, as well financing to individuals for the construction of personal residences. RP Financial, LC. Page 1.17 Construction loans require the payment of interest only during the construction period, which is typically twelve months. Construction loans to builders are generally paid out by maturity when the home is sold. Construction loans to individuals are converted upon completion to a permanent loan made by the Holding Company or are paid out by a permanent loan from a third party lender. Construction loans to individuals are generally subject to the same LTV ratio limits as 1-4 family permanent mortgage loans. The LTV ratio on construction loans to builders is limited to 80.0 percent. As of March 31, 2002, CSBC's outstanding balance of construction loans totaled $15.5 million or 4.7 percent of total loans outstanding. The balance of the mortgage loan portfolio consists of commercial real estate, multi-family and land loans, which are substantially collateralized by properties in the Holding Company's normal lending territory. These loans are originated up to a maximum LTV ratio of 80.0 percent, require a minimum debt-coverage ratio of 1.25 times and have terms of up to 20 years. Commercial real estate, multi-family and land loans generally are offered as ARM loans based on the constant maturity Treasury index, with one, three or five-year repricing periods and for a fixed period not to exceed five years. ARM loans are subject to annual and lifetime repricing caps of 2.0 percent and 5.0 percent, respectively. To a lesser extent, these loans are based on the Holding Company's prime rate or on a fixed rate for a period of generally five years. Properties securing these loans include office buildings, churches, retail space, apartments and land. Land loans serve as a complement to the Holding Company's 1-4 family lending activities, as such loans are primarily secured by single-family lot loans or land that will be used for residential development. As of March 31, 2002, Citizens South's outstanding balance of commercial real estate, multi-family and land loans totaled $32.9 million or 9.9 percent of total loans outstanding. Diversification into non-mortgage lending consists of consumer loans, as well as commercial business loans. The consumer loan portfolio consists primarily of home equity lines of credit. Other types of consumer loans held by the Holding Company include loans secured by deposit accounts, second mortgage loans, automobiles, recreational vehicles, home improvement loans and unsecured personal loans. Home equity lines of credit are floating rate loans tied to The Wall Street Journal Prime Rate and are generally limited to a maximum LTV ratio of 90.0 percent of the combined balance of the home equity line of credit and the first lien. Home equity RP Financial, LC. Page 1.18 lines of credit have terms of up to 15 years. Other consumer loans are made with fixed interest rates and have terms that generally do not exceed five years. As of March 31, 2002, CSBC's consumer loan portfolio totaled $65.6 million or 19.7 percent of total loans outstanding, of which $47.1 million consisted of home equity lines of credit. Commercial business loans offered by the Holding Company consist of floating rate loans tied to the Holding Company's prime rate and fixed rate loans with terms up to seven years. Fixed rate loans are generally extended at the Holding Company's prime rate plus a margin. Commercial business loans offered by the Holding Company consist primarily of secured loans, while the portfolio also includes a minor amount of unsecured loans. The decision to grant a commercial business loan depends primarily on the creditworthiness and cash flow of the borrower and any guarantors. Commercial business loans will continue to be emphasized as an area of lending growth for the Holding Company following the conversion, in which CSBC will be targeting small- and mid-size companies in the local market area as the primary source of commercial loan growth. As of March 31, 2002, Citizens South's outstanding balance of commercial business loans totaled $31.2 million or 9.4 percent of total loans outstanding. Exhibit I-11 provides a summary of the Holding Company's lending activities over the past three and one-half years. The Holding Company's current emphasis on commercial business and consumer lending is highlighted by recent lending volume trends, as such loans represented the Holding Company's most active lending area during the past three and one-half years. Originations of commercial business and consumer loans increased from $27.2 million for the twelve month ended September 30, 1999 ($22.8 million of commercial business loans and $4.4 million of consumer loans) to $52.1 million for the year ended December 31, 2001 ($29.9 million of commercial business loans and $22.1 million of consumer loans). For the quarter ended March 31, 2002, originations of commercial business and consumer loans equaled $14.0 million ($2.7 million of commercial business loans and $11.4 million of consumer loans). Originations of construction loans constituted the second most active lending area for the Holding Company, reaching a peak volume of $8.8 million during the year ended 2001. The Holding Company's relatively low volume of 1-4 family originations, equaling $1.4 million for the year ended December 31, 2001, reflects originations of only adjustable rate loans that are RP Financial, LC. Page 1.19 retained for investment and does not include originations of fixed rates loans that are closed in a third party name. In recent years, the substantial portion of the Holding Company's 1-4 family lending volume has consisted of fixed rate loans. The stronger demand for loan refinancings translated in higher repayments during the year ended December 31, 2001, as loan repayments increased from $46.2 million for the year ended December 31, 2000 to $63.5 million for the year ended December 31, 2001. To facilitate restructuring of the balance sheet for purposes of reducing the interest rate risk and increasing the yield potential of the loan portfolio, the Holding Company sold $13.1 million of loans for the twelve months ended September 30, 1999 and $18.2 million of loans for the twelve months ended December 31, 2000. The loans sold were 1-4 family fixed rate loans and the proceeds realized from the sales were primarily reinvested in short-term mortgages and commercial business and consumer loans. Loan growth was most significant in 2001, as the result of the $170.5 million of loans acquired in connection with the acquisition of Innes Street. Accordingly, the net loans receivable balance increased from $158.8 million at December 31, 2000 to $334.3 million at December 31, 2001. The Holding Company experienced a $10.8 million reduction in net loans receivable during the first quarter of 2002, which was primarily attributable to increased repayments ($32.2 million in the first quarter of 2002 versus $13.2 million for the year ago period). Asset Quality The Holding Company's historical lending emphasis on 1-4 family loans and emphasis on credit risk management have generally served to limit asset quality problems. Exhibit I-12 provides detail of the Holding Company's non-performing assets over the past five and one-half years. Over the past five and one-half years, CSBC's balance of non-performing assets ranged from a high of 0.75 percent of assets at September 30, 1997 to a low of 0.11 percent of assets at December 31, 2000. As shown in Exhibit I-12, the Holding Company's balance of non-performing assets totaled $3.2 million or 0.71 percent of assets at March 31, 2002 and consisted of $1.5 million of non-accruing loans and $1.7 million of real estate owned. The Holding Company's largest non-performing asset currently consists of an office building in Greenville, South Carolina, that is held as real estate owned and accounted for $1.3 million of the real estate RP Financial, LC. Page 1.20 owned balance at March 31, 2002. The REO property was acquired in connection with the acquisition of Innes Street and is listed for sale with an independent real estate sales agent. The Holding Company reviews and classifies assets on a quarterly basis and establishes loan loss provisions based on the overall quality, size and composition of the loan portfolio, as well other factors such as historical loss experience, industry trends and local real estate market and economic conditions. The Holding Company maintained valuation allowances of $3.0 million at March 31, 2002, equal to 0.93 percent of net loans receivable and 95.9 percent of non-performing assets. Funding Composition and Strategy Deposits have consistently accounted for the Holding Company's primary source of funds and at March 31, 2002, deposits equaled 89.6 percent of CSBC's interest-bearing funding composition. Exhibit I-13 sets forth the Holding Company's deposit composition for the past three and one-half years and Exhibit I-14 provides the interest rate and maturity composition of the CD portfolio at March 31, 2002. CDs represent the largest component of the Holding Company's deposit composition, with CSBC's current CD composition reflecting a higher concentration of short-term CDs (maturities of one year or less). As of March 31, 2002, the CD portfolio totaled $239.6 million or 68.0 percent of total deposits and 89.2 percent of the CDs were scheduled to mature in one year or less. As of March 31, 2002, jumbo CDs (CD accounts with balances of $100,000 or more) amounted to $52.8 million or 22.0 percent of total CDs. CSBC does not maintain any brokered CDs. Deposit rates offered by the Holding Company are generally in the middle-to-upper end of the range of rates offered by local competitors. Lower cost savings and transaction accounts comprise the balance of the Holding Company's deposit composition, with such deposits amounting to $112.5 million or 32.0 percent of total deposits at March 31, 2002. Over the past three and one-half years, the Holding Company's deposit composition has exhibited a shift towards a slightly higher concentration of CDs, which was primarily attributable to the relatively high concentration of CDs that comprised Innes Street's deposit composition. As of March 31, 2002, CDs and transaction and savings RP Financial, LC. Page 1.21 accounts represented 68.0 percent and 32.0 percent of the Holding Company's total deposits, respectively, versus comparable ratios of 64.9 percent and 35.1 percent at September 30, 1999. Borrowings serve as an alternative funding source for the Holding Company to support management of funding costs and interest rate risk. The Holding Company maintained $41.0 million of borrowings at March 31, 2002, slightly below the five and one-half year peak of $42.7 million at March 31, 2002. Borrowings held by the Holding Company at March 31, 2002, consisted of $39.0 million of FHLB advances and $2.0 million of other short-term borrowings. FHLB advances held by the Holding Company consist of fixed rate notes for terms of less than 10 years, some of which have a one-time call provision. CSBC's deposit growth, internal funding and stock proceeds are expected to be adequate enough to fund the substantial portion of the Holding Company's lending and investment activities for the intermediate-term. To the extent additional borrowings are utilized by the Holding Company, such borrowings would most likely consist of FHLB advances. Exhibit I-15 provides detail of the Holding Company's borrowing activities during the past three and one-half years. Subsidiary Citizens South Financial Services, Inc., doing business as Citizens South Investment Services, is the only subsidiary that is maintained by the Bank. Citizens South Investment Services operates as an independent agent selling various non-deposit financial products, including mutual funds and annuities. Citizens South Investment Services also offers wealth management and financial planning services, and expects its offering of these services to increase in the future. Legal Proceedings CSBC is periodically involved in routine legal proceedings occurring in the ordinary course of business which, in the aggregate, are believed by management to be immaterial to the financial condition and results of operations of the Holding Company. RP Financial, LC. Page 2.1 II. MARKET AREA Introduction CSBC conducts operations through nine full service branch offices in the Counties of Gaston, Rowan and Iredell. The main office and five branches are maintained in Gaston County in the towns of Gastonia (main office and two branches), Mount Holly, Dallas and Stanley. Two branch offices are maintained in Rowan County in the towns of Salisbury and Rockwell and one branch office is maintained in Iredell County in the town of Statesville. Gaston County is located in the I-85 corridor, approximate twenty miles west of the regional banking center of Charlotte, North Carolina. The branches offices in Iredell and Rowan Counties were acquired in connection with the acquisition of Innes Street and are located approximate 60 miles northeast of the main office. The Holding Company considers its primary market area to be the North Carolina Counties of Gaston, Rowan, Iredell, Mecklenburg, Cabarrus, Lincoln and Cleveland, and the South Carolina County of York. Exhibit II-1 provides information on the Holding Company's office facilities. The primary market area served by CSBC is viewed as mostly suburban in nature, with economic growth supported by the outward expansion of the Charlotte MSA and the region's accessibility as a major transportation hub. Manufacturing serves as the basis of the local economy, with services and wholesale/retail trade constituting the primary industries of employment diversification. The Holding Company's competitive environment includes a large number of thrifts, commercial banks, and other financial services companies, many of which have a regional or national presence. Future business and growth opportunities will be partially influenced by economic and demographic characteristics of the markets served by the Holding Company, particularly the future growth and stability of the regional economy, demographic growth trends, and the nature and intensity of the competitive environment for financial institutions. These factors have been examined to help determine the growth potential that exists for the Holding Company and the relative economic health of the Holding Company's market area. RP Financial, LC. Page 2.2 Market Area Demographics Demographic growth in the Holding Company's market area has been measured by changes in population, number of households and median household income, with trends in those areas summarized by the data presented in Table 2.1. From 1990 through 2001, the primary market area served by CSBC experienced positive growth as measured by population and household growth. All three counties where the Holding Company maintains a branch presence recorded an increase in population since 1990, with Iredell County posting the strongest growth rate (2.9 percent annual growth rate). Growth of the regional economy has been supported by its proximity to Charlotte and its accessibility as a transportation hub, which has spurred economic expansion through attracting businesses to the area's many industrial sites. The regional market area offers immediate access to three Interstate Highways (I-77, I-85 and I-40), as well as two international airports and a rail system. Gaston County is the most populous of the three-county market area, with a 2001 population of 192,000. Population growth rates for both Iredell and Rowan Counties, as well as the State of North Carolina, exceeded the U.S. growth rate, while Gaston County's annual population growth rate of 0.9 percent matched the U.S. growth rate. Projected population growth for the primary market area counties is not expected to vary materially from recent historical trends, with Iredell County's population growth rate projected to remain the strongest among the primary market area counties. Growth in households generally paralleled the population growth rates, with Iredell County exhibiting the highest household growth rate among the primary market area counties. Median household and per capita income measures for the primary market area counties indicate that the faster growing Iredell County market is also a slightly more affluent market area, reflecting the impact of the industrial growth that has occurred in the county. Iredell County was the only primary market area county with a higher median household income than the North Carolina median in 2001, while per capita income in all three of the primary market area counties fell below North Carolina's 2001 per capita income. Median household income increased in all three of the primary market area counties over the past eleven years, with annual growth rates ranging from a low of 2.3 percent in Gaston County to a high of 3.0 percent in Iredell County. Consistent with trends reflected during the 1990s, household income growth is projected to be the strongest in Iredell County over the next five years (3.2 percent annual RP Financial, LC. Page 2.3 (table omitted) RP Financial, LC. Page 2.4 growth), followed by Rowan County (1.2 percent annual growth) and Gaston County (0.9 percent annual growth). Household income distribution measures also imply that Iredell County is a more affluent market area, based on the higher percentage of Iredell County households with incomes of $100,000 or more. Based on these demographic trends, the markets served by CSBC are viewed as being conducive for supporting lending and deposit growth opportunities over the next five years, particularly with respect to the relatively attractive demographic characteristics indicated for Iredell County. National Economic Factors The future success of the Holding Company's operations is partially dependent upon various national and local economic trends. In assessing economic trends over the past year, signs of slower economic growth continued to prevail in the second quarter of 2001, as a number of companies initiated lay-offs to offset profit erosion caused by slackening demand for products and services in general. The economic slow down and the general decline in the stock market combined to erode consumer confidence as well. Despite the general downturn in the economy, the housing sector continued to prosper from the decline in mortgage rates. Home sales of previously owned homes rose in May 2001 to the third highest monthly level ever recorded and year-to-date sales of existing homes were up 2.6 percent compared to a year ago. The slowing economy also negatively impacted the budget surplus, which declined to $2.5 billion in July 2001, half its prior year level. However, inflation remained in-check, as consumer prices held steady with the support of lower energy prices. The September 11, 2001 terrorist attack had negative implications throughout the U.S. economy and increased expectations that a recession was unavoidable. The U.S. economy shrank at a 0.4 percent annual rate in the third quarter of 2001, existing home sales fell 11.7 percent in September and the index of leading economic indicators fell 0.5 percent in September. Consumer confidence in October fell to its lowest level in seven years, as the October unemployment rate hit a five-year high of 5.4 percent. A decline in the manufacturing index for October provided another sign that the economy was continuing to struggle. The Federal Reserve's "beige book" report indicated that economic activity generally remained soft in RP Financial, LC. Page 2.5 October and the first half of November, with evidence of additional slowing in most regions of the U.S. Residential mortgage delinquencies rose in the third quarter, reflecting the impact of a rising unemployment rate. The unemployment rate increased to 5.8 percent in December, although increased working hours in the manufacturing sector provided indications of a possible economic rebound. Signs of a healing economy became more prominent at the beginning of 2002, as manufacturing showed signs of expanding for the first time in 18 months, GDP growth was slightly positive in the fourth quarter of 2001 and the national unemployment rate declined from 5.8 percent in December 2001 to 5.6 percent in January 2002. January data for industrial production and retail sales provided further signs that the economic recovery was gaining traction and raised hopes that the recession was nearing an end. An upward revision in the fourth quarter GDP, a strong increase in a key manufacturing index for February and a decline in the February unemployment rate signaled that the U.S. economy was recovering more rapidly than expected. Consumer confidence surged in March to its highest level since December 2000, increasing expectations of a broad economic recovery in the U.S. The U.S. economy expanded at a 5.6 percent annualized rate in the first quarter of 2002, the fastest pace in two years. However, the breadth of the economic recovery did not appear to be broad based and showed signs of stalling, as corporate profits remained depressed and pessimism about the economic outlook continued to restrain capital spending and hiring. Economic data for April 2002 provided indications that the economic recovery was tapering off in the second quarter, based on a slower rate of expansion in the manufacturing sector and a decline in construction activity. While the labor market added jobs in April, the unemployment rate rose from 5.7 percent in March to 6.0 percent in April, its highest level in nearly eight years. Notwithstanding the jump in the unemployment rate, consumer confidence remained high and retail sales surged higher than expected in April. The upswing in the economy continued into May 2002 based on an increase in manufacturing activity, but most factories remained reluctant to add workers. While the labor market grew meagerly in May, which reduced the unemployment rate to 5.8, the recovery in employment continued to trail the rest of the economy. Interest rates generally trended lower through most of 2001. Concerns of a slumping RP Financial, LC. Page 2.6 economy prompted the Federal Reserve to reduce the overnight federal funds rate by 50 basis points in early-January 2001, which was followed by ten more rate cuts over the course of 2001. In total, the eleven rate cuts by the Federal Reserve sliced the target federal funds rate from 6.50 percent to 1.75 percent and provided for a reversion to a normal yield curve. The rate cuts implemented throughout 2001 served to widen the gap between short-and long-term interest rates as the year progressed and provided for a general decline in consumer loan rates. Lower mortgage rates spurred peak lending volumes for 1-4 family lenders, as the result of both refinancing activity as well as strong demand for new home purchases. Expectations of a slow economic recovery and low inflation provided for a stable interest rate environment at the beginning of 2002. The Federal Reserve left interest rates unchanged at its late-January meeting, based on indications that the economy stopped shrinking at the end of last year. After stabilizing through mid-February, interest rates moved higher in late-February and early-March as the economic rebound increased expectations that the Federal Reserve may raise interest rates by mid-year to keep inflation in check. The upward trend interest rates continued to prevail through most of March, as the Federal Reserve left interest rates unchanged at its mid-March meeting and indicated a shift in its policy directive to a neutral stance from one that favored additional easing. Interest rates eased lower at the beginning of the second quarter of 2002, as the economic recovery showed signs of faltering and the Federal Reserve indicated that a near term rate increase was becoming increasingly unlikely based on the continued uncertainty about the strength of the economic recovery. In fact, at its early-May meeting, the Federal Reserve left rates at a 40-year low, saying that the risks of economic weakness and inflation were equally balanced. The mild downward trend in interest rates continued through May and into-early June, as selling pressure in stocks and political turmoil abroad further added to the attractiveness of U.S. Treasuries as a safe investment haven. As of June 14, 2002, one- and ten-year U.S. government bonds were yielding 2.05 percent and 4.89 percent, respectively, versus comparable year ago yields of 3.56 percent and 5.26 percent. Exhibit II-2 provides historical interest rate trends from 1991 through June 14, 2002 RP Financial, LC. Page 2.7 Local Economy Manufacturing jobs serve as the basis of the regional economy, producing such goods as textiles, apparel, fabricated metals, machinery, chemicals and automotive transportation equipment. Services and wholesale/retail trade represent the primary area of employment diversification in all three of the primary market area counties. Gaston County is one of the state's largest textile producers and textile manufacturers maintain a presence throughout the three-county primary market area. Other major sources of employment in the three-county market area include manufacturers of automotive machinery, hospitals, local government and school systems, and the corporate headquarters of Food Lion which is based in Rowan County. While growth in the regional market area has facilitated greater diversification in the local economy, the large presence of manufacturing increases the local economy's exposure to a downturn in the national economy compared to more economically diversified markets such as Charlotte. Comparative unemployment rates for the primary market area, as well as for the U.S. and North Carolina, are shown in Table 2.2. April 2002 unemployment rates show that Gaston and Iredell Counties maintained higher unemployment rates compared to the U.S. unemployment rate of 5.7 percent, but only Gaston County's unemployment rate of 7.5 percent exceeded North Carolina's unemployment rate of 6.5 percent. Consistent with the U.S. and the State of North Carolina, current unemployment rates for all three of the primary market area counties were higher compared to a year ago. The rise in the local unemployment rates reflect the influence of the slow down in the national economy on the local manufacturing industries, as layoffs in the textile and transportation equipment industries have contributed to the rise in unemployment in the primary market area counties. RP Financial, LC. Page 2.8 Table 2.2 Unemployment Trends(1) April 2001 April 2002 Region Unemployment Unemployment ------ ------------ ------------ United States 4.2% 5.7% North Carolina 4.7 6.5 Gaston County 6.3 7.5 Iredell County 4.5 6.4 Rowan County 4.7 5.6 (1) Unemployment rates have not been seasonally adjusted. Source: U.S. Bureau of Labor Statistics. Market Area Deposit Characteristics and Competition Competition among financial institutions in the Holding Company's market area is significant, and, as larger institutions compete for market share to achieve economies of scale, the market environment for the Holding Company's products and services is expected to remain highly competitive in the future. Among the Holding Company's competitors are much larger and more diversified institutions, which have greater resources than maintained by CSBC. Financial institution competitors in the Holding Company's primary market area includes other locally based thrifts and banks, as well as regional, super regional and national banks. From a competitive standpoint, CSBC has sought to emphasize its community orientation in the markets served by its branches. The Holding Company's retail deposit bases are closely tied to the economic fortunes of the regional market area and, in particular, the areas of the region that are nearby to one of CSBC's nine branches. Table 2.3 displays deposit market trends from June 30, 1998 through June 30, 2001 for the three counties where the Holding Company maintains branches. Prior to the acquisition of Innes Street Financial and its wholly-owned bank subsidiary, Citizens Bank, all of the Holding Company's branches were maintained in Gaston County. Accordingly, the deposit market share data indicated for Iredell and Rowan Counties reflects deposit activity of the Citizens Bank branches prior to the completion of the acquisition. The data indicates that deposit growth in the Holding Company's primary market area has been positive, although less RP Financial, LC. Page 2.9 (table omitted) RP Financial, LC. Page 2.10 than the overall growth rate posted by banks and thrifts in the State of North Carolina. Deposits maintained by all commercial banks and thrifts in North Carolina increased at an annual rate of 12.7 percent from June 30, 1998 through June 30, 2001, as the result of growth in commercial bank deposits. Comparatively, North Carolina savings institutions experienced a decline in deposits, which was largely attributable to the consolidation of savings institutions into commercial banks. However, savings institutions experienced positive deposit growth in all three of primary market area counties that are served by the Holding Company's branches. CSBC's largest balance and largest market share of deposits is maintained in Gaston County, where the Holding Company is headquartered. The Holding Company's $182.1 million of deposits at the Gaston County branches represented a 10.5 percent market share of thrift and bank deposits at June 30, 2001. CSBC's 7.4 percent annual deposit growth rate outpaced Gaston County's overall deposit growth rate of 3.0 percent, which translated into an increase in deposit market share from 9.3 percent to 10.5 percent over the three-year period covered in Table 2.3. Growth in deposit market share was in part supported by increasing the number of branches maintained in Gaston County from four to six during the three year period. From June 30, 1998 through June 30, 2001, annual deposit growth rates for the branch maintained in Iredell County and two branches maintained in Rowan County equaled 1.6 percent and 1.9 percent, respectively. Comparable deposit growth rates for all banks and thrift branches maintained in Iredell and Rowan Counties equaled 8.7 percent and 4.3 percent, respectively. Accordingly, the Iredell County branch experienced a decline in deposit market share from 4.7 percent at June 30, 1998 to 4.2 percent at June 30, 2001. Over the same time period, the deposit market share for the two Rowan County branches declined from 13.8 percent to 13.0 percent. In addition to the deposit growth that was realized by the acquisition of Innes Street, the Holding Company should also continue to benefit from its favorable image as a locally-owned and community-oriented institution, as the trend of consolidation among financial institutions is expected to provide CSBC with additional opportunities to acquire customers, facilities and key personnel that become available as the result of community banks being acquired. Future deposit growth may also be enhanced by the infusion of the conversion proceeds, as the additional capital will improve CSBC's competitive position and leverage capacity. Deposit RP Financial, LC. Page 2.11 growth could also be enhanced by possible expansion of the branch network, either through establishing additional branch sites or through acquisition. RP Financial, LC. Page 3.1 III. PEER GROUP ANALYSIS This chapter presents an analysis of CSBC's operations versus a group of comparable savings institutions (the "Peer Group") selected from the universe of all publicly-traded savings institutions in a manner consistent with the regulatory valuation guidelines. The basis of the pro forma market valuation of CSBC is derived from the pricing ratios of the Peer Group institutions, incorporating valuation adjustments for key differences in relation to the Peer Group. Since no Peer Group can be exactly comparable to CSBC, key areas examined for differences are: financial condition; profitability, growth and viability of earnings; asset growth; primary market area; dividends; liquidity of the shares; marketing of the issue; management; and effect of government regulations and regulatory reform. Peer Group Selection The Peer Group selection process is governed by the general parameters set forth in the regulatory valuation guidelines. Accordingly, the Peer Group is comprised of only those publicly-traded savings institutions whose common stock is either listed on a national exchange (NYSE or AMEX), or is NASDAQ listed, since their stock trading activity is regularly reported and generally more frequent than non-publicly traded and closely-held institutions. Non-listed institutions are inappropriate since the trading activity for thinly-traded or closely-held stocks is typically highly irregular in terms of frequency and price and thus may not be a reliable indicator of market value. We have also excluded from the Peer Group those companies under acquisition or subject to rumored acquisition, mutual holding companies and recent conversions, since their pricing ratios are subject to unusual distortion and/or have limited trading history. A recent listing of the universe of all publicly-traded savings institutions is included as Exhibit III-1. Ideally, the Peer Group, which must have at least 10 members to comply with the regulatory valuation guidelines, should be comprised of locally or regionally-based institutions with comparable resources, strategies and financial characteristics. There are approximately 248 publicly-traded institutions nationally and, thus, it is typically the case that the Peer Group will be comprised of institutions with relatively comparable characteristics. To the extent that RP Financial, LC. Page 3.2 differences exist between the converting institution and the Peer Group, valuation adjustments will be applied to account for the differences. Since CSBC will be a full public company upon completion of the offering, we considered only full public companies to be viable candidates for inclusion in the Peer Group. From the universe of publicly-traded thrifts, we selected 13 institutions with characteristics similar to those of CSBC. In the selection process, we applied two "screens" to the universe of all public companies: . Screen #1. North Carolina institutions with assets between $250 million and $750 million and tangible equity-to-assets ratios of greater than 6.0 percent. One company met the criteria for Screen #1 and was included in the Peer Group: Cooperative Bancshares. Exhibit III-2 provides financial and public market pricing characteristics of all publicly-traded thrifts in North Carolina. . Screen #2. Southeast institutions with assets between $250 million and $750 million, tangible equity-to-assets ratios between 8.0 percent and 20.0 percent, and positive core return on equity ratios between 5.0 percent and 10.0 percent. Three companies met the criteria for Screen #2 and all were included in the Peer Group: Acadiana Bancshares, Inc. of Louisiana, Community Financial Corp. of Virginia, and First Federal Bancshares of Arkansas. Exhibit III-3 provides financial and public market pricing characteristics of all publicly-traded Southeast thrifts. . Screen #3. Midwest institutions with assets between $250 million and $750 million, tangible equity-to-assets ratios between 8.0 percent and 20.0 percent, and positive core return on equity ratios between 5.0 percent and 10.0 percent. Nine companies met the criteria for Screen #2 and all were included in the Peer Group: Citizens First Financial Corp. of Illinois, EFC Bancorp, Inc. of Illinois, First Capital, Inc. of Indiana, First SecurityFed Financial, Inc. of Illinois, Guaranty Federal Bancshares of Missouri, HMN Financial, Inc. of Minnesota, HopFed Bancorp of Kentucky, LSB Financial Corp. of Lafayette Indiana, and Peoples Community Bancorp of Ohio. Exhibit III-4 provides financial and public market pricing characteristics of all publicly-traded Midwest thrifts. Table 3.1 shows the general characteristics of each of the thirteen Peer Group companies and Exhibit III-5 provides summary demographic and deposit market share data for the primary market areas served by each of the Peer Group companies. While there are expectedly some differences between the Peer Group companies and CSBC, we believe that the Peer Group companies, on average, provide a good basis for valuation subject to valuation adjustments. The following sections present a comparison of CSBC's financial condition, income and expense trends, loan composition, interest rate risk and credit risk versus the Peer Group as of the most recent publicly available date. RP FINANCIAL, LC. Financial Services Industry Consultants 1700 North Moore Street, Suite 2210 Arlington, Virginia 22209 (703) 528-1700 Page 3.3 Table 3.1 Peer Group of Publicity-Traded Thrifts June 17, 2002(1) (table omitted) RP Financial, LC. Page 3.4 A summary description of the key characteristics of each of the Peer Group companies is detailed below. ... Acadiana Bancshares, Inc of LA. Selected due to similar tangible capital position, comparable interest-earning asset composition, comparable return on average assets, similar level of operating expenses and favorable credit quality measures. ... Citizens First Fin. Corp. of IL. Selected due to similar tangible capital position, comparable return on average assets and comparable concentration of 1-4 family permanent mortgage loans. ... Community Fin. Corp. of VA. Selected due to comparable funding composition, similar earnings contribution from sources of non-interest operating income and favorable credit quality measures. ... Cooperative Bancshares of NC. Selected due to North Carolina market area, comparable asset size, similar tangible capital position, comparable funding composition and favorable credit quality measures. ... EFC Bancorp, Inc. of Elgin IL. Selected due to comparable size of branch network, comparable interest-earning asset composition and favorable credit quality measures. ... First Capital, Inc. of IN. Selected due to same size of branch network, comparable interest-earning asset composition, similar funding composition, comparable lending emphasis on commercial real estate and commercial business loans and favorable credit quality measures. ... First Fed. Bancshares of AR. Selected due to comparable interest-earning asset composition, similar funding composition, comparable lending emphasis on commercial real estate and commercial business loans and favorable credit quality measures. ... First SecurityFed Fin. of IL. Selected due to comparable asset size and favorable credit quality measures. ... Guaranty Fed. Bancshares of MO. Selected due to same size of branch network, comparable asset size and favorable credit quality measures. ... HMN Financial, Inc. of MN. Selected due to comparable degree of diversification into higher risk types of lending and favorable credit quality measures. ... HopFed Bancorp of KY. Selected due to similar funding composition, comparable lending emphasis on commercial real estate and commercial business loans and favorable credit quality measures. ... LSB Fin. Corp. of Lafayette IN. Selected due to similar tangible capital position, comparable level of operating expenses and favorable credit quality measures. ... Peoples Community Bancorp of OH. Selected due to comparable asset size, similar size of branch network, similar tangible capital position and comparable return on average assets. RP Financial, LC. Page 3.5 In aggregate, the Peer Group companies maintain a comparable level of capital as the industry average (10.55 percent of assets versus 10.32 percent for all public companies), generate slightly higher earnings as a percent of average assets (0.81 percent core ROAA versus 0.73 percent for all public companies), and generate a slightly lower ROE (7.41 percent core ROE versus 7.48 percent for all public companies). Overall, the Peer Group's average P/B ratio and average core P/E multiple were below the respective averages for all publicly-traded thrifts. All Publicly-Traded Peer Group Financial Characteristics (Averages) Assets ($Mil) $ 1,921 $ 437 Market capitalization ($Mil) $ 271 $ 52 Equity/assets (%) 10.32% 10.55% Core return on assets (%) 0.73% 0.81% Core return on equity (%) 7.48% 7.41% Pricing Ratios (Averages)(1) ------------------------- Core price/earnings (x) 16.97x 16.02x Price/book (%) 134.19% 112.84% Price/assets (%) 13.48% 11.93% (1) Based on market prices as of June 14, 2002. Ideally, the Peer Group companies would be comparable to CSBC in terms of all of the selection criteria, but the universe of publicly-traded thrifts does not provide for an appropriate number of such companies. However, in general, the companies selected for the Peer Group were fairly comparable to CSBC, as will be highlighted in the following comparative analysis. Financial Condition Table 3.2 shows comparative balance sheet measures for CSBC and the Peer Group, reflecting the expected similarities and some differences given the selection procedures outlined above. The Holding Company's and the Peer Group's ratios reflect balances as of March 31, 2002, unless indicated otherwise for the Peer Group companies. CSBC's equity-to-assets ratio of 9.5 percent was slightly below the Peer Group's average net worth ratio of 10.5 percent. However, on a tangible capital basis, the gap between the Holding Company's and the Peer RP FINANCIAL, LC. Financial Services Industry Consultants 1700 North Moore Street, Suite 2210 Arlington, Virginia 22209 (703) 528-1700 Page 3.6 Table 3.2 Balance Sheet Composition and Growth Rates Comparable Institution Analysis As of March 31, 2002 (table omitted) RP Financial, LC. Page 3.7 Group's capital ratios became more significant. Tangible equity-to-assets ratios for the Holding Company and the Peer Group equaled 7.6 percent and 10.5 percent, respectively, reflecting the more significant impact of goodwill and intangibles on CSBC's balance sheet that was created in connection with the acquisition of Innes Street. However, the Holding Company's pro forma tangible capital position will increase with the addition of stock proceeds and will likely exceed the Peer Group's ratio following the conversion. The increase in CSBC's pro forma capital position will be favorable from a risk perspective and in terms of future earnings potential that could be realized through leverage and lower funding costs. At the same time, the Holding Company's higher pro forma capitalization will also initially depress its return on equity. Both the Holding Company's and the Peer Group's capital ratios reflected capital surpluses with respect to the regulatory capital requirements, with the Peer Group's ratios currently exceeding the Holding Company's ratios. On a pro forma basis, the Holding Company's surpluses will be more comparable to the Peer Group's, as approximately 50.0 percent of the net conversion proceeds will be infused into Citizen Bank as additional capital. The interest-earning asset compositions for the Holding Company and the Peer Group were somewhat similar, with loans constituting the bulk of interest-earning assets for CSBC and the Peer Group. The Peer Group maintained a higher concentration of loans as a percent of assets than CSBC (75.9 percent versus 73.0 percent for the Peer Group), while the Holding Company's cash and investments-to-assets ratio was also slightly lower than the comparable ratio for the Peer Group (19.4 percent versus 20.4 percent for the Peer Group). Overall, CSBC's interest-earning assets amounted to 92.4 percent of assets, which was somewhat below the comparable Peer Group ratio of 96.3 percent. Goodwill and intangibles, equal to 2.0 percent of assets at March 31, 2002, and the cash value of life insurance policies, equal to 1.5 percent of assets at March 31, 2002, were factors that accounted for the Holding Company's lower ratio of interest-earning assets. CSBC's funding liabilities reflected some differences relative to that of the Peer Group's funding composition. The Holding Company's deposits equaled 79.4 percent of assets, which was above the Peer Group average of 67.5 percent. Comparatively, borrowings accounted for a lower portion of the Holding Company's interest-bearing funding composition, as reflected by borrowings-to-assets ratios of 9.3 percent and 23.1 percent for CSBC and the Peer Group, RP Financial, LC. Page 3.8 respectively. Total interest-bearing liabilities maintained as a percent of assets equaled 88.7 percent and 88.2 percent for CSBC and the Peer Group, respectively. A key measure of balance sheet strength for a thrift institution is its interest-earning assets to interest-bearing liabilities ("IEA/IBL") ratio. Presently, the Holding Company's IEA/IBL ratio is lower than the Peer Group's ratio, based on respective ratios of 104.2 percent and 109.2 percent. The additional capital realized from stock proceeds should provide CSBC with an IEA/IBL ratio that is more comparable to the Peer Group's IEA/IBL ratio, as the increase in capital realized from CSBC's stock offering will serve to lower the level of interest-bearing liabilities funding assets and will be primarily deployed into interest-earning assets. The growth rate section of Table 3.2 shows annual growth rates for key balance sheet items, based on annual growth for the twelve months ended March 31, 2002. Asset growth rates of positive 65.3 percent and positive 7.8 percent were posted by the Holding Company and the Peer Group, respectively, with the Holding Company's significantly higher growth rate supported by the growth realized from the acquisition of Innes Street. CSBC's asset growth was realized through a 96.4 percent increase in loans, as the funding of the cash acquisition resulted in a slight decline in the cash and investments balance. Comparatively, asset growth for the Peer Group showed growth in loans and cash and investments, with a higher growth rate indicated for cash and investments. Overall, the growth provided by the Innes Street acquisition should support greater earnings growth relative to the earnings growth generated from the Peer Group's asset growth measures. Following the conversion, CSBC's leverage capacity will be somewhat greater than the Peer Group's. Deposit growth for the Holding Company funded asset growth as well as a reduction in borrowings, while growth in both deposits and borrowings were utilized to fund the Peer Group's asset growth. The Holding Company's significantly higher deposit growth rate of 95.2 percent, versus 12.5 percent for the Peer Group, was again supported by acquisition related growth. Capital growth rates posted by the Holding Company and the Peer Group equaled positive 4.2 percent and positive 1.0 percent, respectively. Factors contributing to the Holding Company's higher capital growth rate, despite a lower return on average assets ratio, included maintenance of a lower capital position and the payment of cash dividends on only the shares RP Financial, LC. Page 3.9 held by the public stockholders. However, more significantly, as the result of the goodwill and intangibles created by the acquisition of Innes Street, the Holding Company experienced a 17.3 percent decline in tangible net worth for the twelve month period, versus a 1.6 percent increase recorded by the Peer Group. The increase in capital realized from conversion proceeds, as well as dividend payments on 100 percent of the stock outstanding will be limiting factors on the Holding Company's capital growth rate initially following the stock offering. Income and Expense Components CSBC and the Peer Group reported net income to average assets ratios of 0.65 percent and 0.90 percent, respectively (see Table 3.3), based on earnings for the twelve months ended March 31, 2002, unless indicated otherwise for the Peer Group companies. A higher net interest margin and a lower level of operating expenses primarily accounted for the Peer Group's higher return, which was partially offset by the Holding Company's lower loss provisions, higher level of non-interest operating income and lower effective tax rate. As set forth in Chapter I, earnings ratios for the Holding Company are based on average assets calculated on quarter end assets over the past five quarters, of which two quarters included the higher asset balance that resulted from the acquisition of Innes Street. However, since the acquisition became effective on December 31, 2001, the earnings for the twelve month period ending March 31, 2002 includes only one quarter of the incremental increase in earnings that was provided by the acquisition of Innes Street. Accordingly, in assessing CSBC's earnings strength relative to the Peer Group's, the downward effect on the Holding Company's return on assets ratio as well as its other income and expense ratios will be taken into consideration in the valuation adjustments applied in Chapter IV. The Peer Group's stronger net interest margin resulted from a higher interest income ratio, which was partially offset by the Holding Company's lower interest expense ratio. The Peer Group's higher interest income ratio was realized through maintaining a higher yield on interest-earning assets (6.63 percent versus 6.42 percent for the Holding Company) and a higher level of interest-earning assets as a percent of total assets (96.3 percent versus 92.4 percent for the Holding Company). The lower interest expense ratio posted by the Holding Company was RP Financial, LC. - ------------------------------------------- Financial Services Industry Consultants 1700 North Moore Street, Suite 2210 Arlington, Virginia 22209 (703) 528-1700 Page 3.10 (table omitted) RP Financial, LC. Page 3.11 supported by its lower cost of funds (3.82 percent versus 4.00 percent for the Peer Group), as CSBC and the Peer Group maintained comparable levels of interest-bearing liabilities as a percent of assets (88.7 percent versus 88.2 percent for the Peer Group). Overall, CSBC and the Peer Group reported net interest income to average assets ratios of 2.53 percent and 3.17 percent, respectively. In another key area of core earnings strength, the Holding Company maintained a higher level of operating expenses than the Peer Group. For the period covered in Table 3.3, the Holding Company and the Peer Group reported operating expense to average assets ratios of 2.55 percent and 2.20 percent, respectively. The Holding Company's higher operating expense ratio was in part attributable to the more significant impact of goodwill amortization on CSBC's earnings. Another factor contributing to the Holding Company's higher operating expense ratio was maintenance of a funding composition with a higher concentration of deposits, which are more costly to service than borrowings. Notwithstanding the Peer Group's lower operating expense ratio, the Holding Company was slightly more efficient than Peer Group in terms of number of employees maintained relative to asset size. Assets per full time equivalent employee equaled $4.6 million for the Holding Company, versus a comparable measure of $4.1 million for the Peer Group. On a post-offering basis, the Holding Company's operating expenses can be expected to increase with the addition of the stock benefit plans that will implemented in connection with the second step conversion offering. At the same time, CSBC's capacity to leverage operating expenses will be greater following the increase in capital realized from the infusion of net conversion proceeds. When viewed together, net interest income and operating expenses provide considerable insight into a thrift's earnings strength, since those sources of income and expenses are typically the most prominent components of earnings and are generally more predictable than losses and gains realized from the sale of assets or other non-recurring activities. In this regard, as measured by their expense coverage ratios (net interest income divided by operating expenses), the Holding Company earnings strength was less favorable than the Peer Group's. Expense coverage ratios posted by CSBC and the Peer Group equaled 0.99x and 1.44x, respectively. An expense coverage ratio of greater than 1.0x indicates that an institution is able to sustain pre-tax profitability without having to rely on non-interest sources of income. RP Financial, LC. Page 3.12 Sources of non-interest operating income provided a more significant contribution to the Holding Company's earnings, with such income amounting to 0.98 percent and 0.44 percent of CSBC's and the Peer Group's average assets, respectively. While CSBC's higher concentration of deposits funding assets contributed to its higher operating expense ratio, the fees generated from the deposits also contributed to its higher level of non-interest operating income. Taking non-interest operating income into account in comparing the Holding Company's and the Peer Group's earnings, CSBC's efficiency ratio of 69.5 percent was less favorable than the Peer Group's efficiency ratio of 59.6 percent. Loan loss provisions had a larger impact on the Peer Group's earnings, amounting to 0.19 percent and 0.05 percent of the Peer Group's and CSBC's average assets, respectively. The higher level of loss provisions indicated for the Peer Group average was largely the result of the significant loss provisions established by one company in the Peer Group, Peoples Community Bancorp of Ohio, which established loss provisions equal to 1.09 percent of average assets. Net gains made a slightly larger contribution to the Peer Group's earnings, with such gains amounting to 0.11 percent and 0.03 percent of average assets for the Peer Group and CSBC, respectively. Given the less predictable and more non-recurring nature of gains and losses resulting from the sale of loans and investments, as well as other assets, the net gains reflected in the Holding Company's and the Peer Group's earnings will be discounted in evaluating the relative strengths and weaknesses of their respective earnings. Extraordinary items were not a factor in either the Holding Company's or the Peer Group's earnings. Taxes were a slightly larger factor in the Peer Group's earnings, as CSBC and the Peer Group posted effective tax rates of 31.88 percent and 34.25 percent, respectively. Loan Composition Table 3.4 presents data related to the loan composition of CSBC and the Peer Group. In comparison to the Peer Group, the Holding Company's loan portfolio composition reflected a lower concentration in the aggregate of 1-4 family residential mortgage loans and mortgage-backed securities (47.4 percent versus 53.6 percent for the Peer Group). A higher concentration of 1-4 family loans substantially accounted for the Peer Group's higher ratio, as CSBC and the RP Financial, LC. - ------------------------------------------ Financial Services Industry Consultants 1700 North Moore Street, Suite 2210 Arlington, Virginia 22209 (703) 528-1700 Page 3.13 (table omitted) RP Financial, LC. Page 3.14 Peer Group maintained comparable ratios of mortgage-backed securities (5.2 percent of assets versus 5.4 percent for the Peer Group). Loans serviced for others represented a slightly larger off-balance sheet item for the Holding Company, equaling $39.8 million and $28.2 million for CSBC and the Peer Group, respectively. However, both the Holding Company's and the Peer Group's relatively low balances of loans serviced for others imply an operating philosophy of typically retaining 1-4 family loan originations for investment or, as is the case with CSBC, not retaining the servicing on fixed rate loan originations either through selling the loans servicing released or closing the loans in a third party name. The Holding Company's and the Peer Group's low balance of loans serviced for others translated into modest balances of servicing intangibles, as servicing assets equaled 0.11 percent and 0.08 percent of the Holding Company's and the Peer Group's assets, respectively. Diversification into higher risk types of lending was more significant for Holding Company, largely on the basis of its greater diversification into consumer loans. However, the major potion of the Holding Company's consumer loan portfolio consists of loans secured by 1-4 family properties, which are generally viewed as lower credit risk loans compared to consumer loans that are secured by other types of collateral or are unsecured personal loans. Consumer loans equaled 14.8 percent of the Holding Company's assets, which was significantly above the comparable Peer Group ratio of 4.0 percent. The Peer Group's lending diversification consisted primarily of commercial real estate/ multi-family loans and construction/land loans, with those portfolios equaling 14.1 percent and 7.4 percent of assets, respectively. Beyond consumer loans, lending diversification for the Holding Company consisted primarily of commercial business loans (7.0 percent of assets) and commercial real/multi-family loans (6.0 percent of assets). Commercial business loans represented a minor area of lending diversification for the Peer Group, equaling 3.0 percent of assets. Overall, the Holding Company's more significant lending diversification and the Peer Group's higher concentration of loans comprising total assets translated into comparable risk-weighted assets-to-assets ratios of 64.8 percent for CSBC and 64.6 percent for the Peer Group, with both ratios exceeding the comparable ratio for all publicly-traded companies of 59.9 percent. Both the Holding Company's and the Peer Group's loan portfolio compositions indicated more significant lending diversification into higher risk types of lending compared to all publicly-traded thrifts, on average. RP Financial, LC. Page 3.15 Interest Rate Risk Table 3.5 reflects various key ratios highlighting the relative interest rate risk exposure of the Holding Company versus the Peer Group. In terms of balance sheet composition, CSBC's interest rate risk characteristics were considered to be less favorable than the Peer Group's, as implied by the Peer Group's higher tangible equity-to-assets and IEA/IBL ratios. A lower level of non-interest earning assets also represented an advantage for the Peer Group with respect to limiting interest rate risk associated with the balance sheet. On a pro forma basis, the infusion of stock proceeds should serve to provide the Holding Company with tangible equity-to-assets and IEA/IBL ratios that are more comparable to the Peer Group's ratios, although the Holding Company will continue to maintain a higher ratio of non-interest earning assets compared to the Peer Group. To analyze interest rate risk associated with the net interest margin, we reviewed quarterly changes in net interest income as a percent of average assets for CSBC and the Peer Group. In general, the relative fluctuations in the Holding Company's and the Peer Group's net interest income to average assets ratios implied there was a greater degree of interest rate risk associated with the Holding Company's net interest income, based on the greater volatility indicated for the quarterly changes in CSBC's net interest income measures. The stability of the Holding Company's net interest margin should be enhanced by the infusion of stock proceeds, as interest rate sensitive liabilities will be funding a lower portion of CSBC's assets. Additionally, the significant changes indicated in the Holding Company's quarterly net interest income ratios for the quarters ending December 31, 2001 and March 31, 2002 were mostly related to the impact of the purchase accounting acquisition of Innes Street, as opposed to interest rate fluctuations impacting yields and costs. Accordingly, going forward, quarterly changes in the Holding Company's net interest income ratios should be more comparable to the Peer Group measures. Credit Risk The Holding Company's credit risk exposure appears to be somewhat similar to the Peer Group's, on average, based on their comparable ratios of non-performing assets and reserves as a RP Financial, LC. - ------------------------------------------ Financial Services Industry Consultants 1700 North Moore Street, Suite 2210 Arlington, Virginia 22209 (703) 528-1700 Page 3.16 (table omitted) RP Financial, LC. Page 3.17 percent of non-performing assets. As shown in Table 3.6, the Holding Company's ratio of non-performing assets and accruing loans that are more than 90 days past due equaled 0.71 percent of assets, which approximated the comparable Peer Group ratio of 0.70 percent. The Holding Company maintained a lower non-performing loans/loans ratio than the Peer Group (0.45 percent versus 0.77 percent for the Peer Group), as real estate owned comprised a higher portion of the Holding Company's non-performing assets balance (0.38 percent of assets versus 0.06 percent of assets for the Peer Group). The Holding Company and the Peer Group maintained comparable levels of loss reserves as a percent of non-performing assets and accruing loans that are more than 90 days past due (95.9 percent versus 107.3 percent for the Peer Group) and as a percent of non-performing loans (208.1 percent versus 192.1 percent for the Peer Group). Loss reserves maintained as percent of loans were slightly higher for the Holding Company, equaling 0.93 percent and 0.76 percent of loans receivable for the Holding Company and the Peer Group, respectively. Net loan charge-offs were not considered to be material for either the Holding Company or the Peer Group. Summary Based on the above analysis and the criteria employed in the selection of the companies for the Peer Group, RP Financial concluded that the Peer Group forms a reasonable basis for determining the pro forma market value of CSBC. Such general characteristics as asset size, capital position, interest-earning asset composition, funding composition, core earnings measures, loan composition, credit quality and exposure to interest rate risk all tend to support the reasonability of the Peer Group from a financial standpoint. Those areas where differences exist will be addressed in the form of valuation adjustments to the extent necessary. RP FINANCIAL LC. - --------------------------------------------- Financial Services Industry Consultants 1700 North Moore Street, Suite 2210 Arlington, Virginia 22209 (703) 528-1700 Page 3.18 (table omitted) RP Financial, LC. Page 4.1 IV. VALUATION ANALYSIS Introduction This chapter presents the valuation analysis and methodology used to determine CSBC's estimated pro forma market value of the common stock to be issued in conjunction with the conversion transaction. The valuation incorporates the appraisal methodology promulgated by the OTS, particularly regarding selection of the Peer Group, fundamental analysis on both the Holding Company and the Peer Group, and determination of the Holding Company's pro forma market value utilizing the market value approach. Appraisal Guidelines The OTS written appraisal guidelines, originally released in October 1983 and updated in late-1994, specify the market value methodology for estimating the pro forma market value of an institution pursuant to a mutual-to-stock conversion. The valuation methodology provides for: (1) the selection of a peer group of comparable publicly-traded institutions, excluding from consideration institutions which have recently converted, subject to acquisition or are in MHC form; (2) a financial and operational comparison of the subject company to the selected peer group, identifying key differences and similarities; and (3) a valuation analysis in which the pro forma market value of the subject company is determined based on the market pricing of the peer group as of the date of valuation, incorporating valuation adjustments for key differences. In addition, the pricing characteristics of recent conversions, both at conversion and in the aftermarket, must be considered. RP Financial Approach to the Valuation The valuation analysis herein complies with such regulatory approval guidelines. Accordingly, the valuation incorporates a detailed analysis based on the Peer Group, discussed in Chapter III, which constitutes "fundamental analysis" techniques. Additionally, the valuation incorporates a "technical analysis" of recently completed stock conversions, including closing pricing and aftermarket trading of such offerings. It should be noted that such analyses cannot RP Financial, LC. Page 4.2 possibly fully account for all the market forces which impact trading activity and pricing characteristics of a stock on a given day. The pro forma market value determined herein is a preliminary value for the Holding Company's to-be-issued stock. Throughout the conversion process, RP Financial will: (1) review changes in the Holding Company's operations and financial condition; (2) monitor the Holding Company's operations and financial condition relative to the Peer Group to identify any fundamental changes; (3) monitor the external factors affecting value including, but not limited to, local and national economic conditions, interest rates, and the stock market environment, including the market for thrift stocks; and (4) monitor pending conversion offerings (including those in the offering phase) both regionally and nationally. If material changes should occur prior to closing the offering, RP Financial will evaluate if updated valuation reports should be prepared reflecting such changes and their related impact on value, if any. RP Financial will also prepare a final valuation update at the closing of the offering to determine if the prepared valuation analysis and resulting range of value continues to be appropriate. The appraised value determined herein is based on the current market and operating environment for the Holding Company and for all thrifts. Subsequent changes in the local and national economy, the legislative and regulatory environment, the stock market, interest rates, and other external forces (such as natural disasters or major world events), which may occur from time to time (often with great unpredictability) may materially impact the market value of all thrift stocks, including CSBC's value, or CSBC's value alone. To the extent a change in factors impacting the Holding Company's value can be reasonably anticipated and/or quantified, RP Financial has incorporated the estimated impact into its analysis. Valuation Analysis A fundamental analysis discussing similarities and differences relative to the Peer Group was presented in Chapter III. The following sections summarize the key differences between the Holding Company and the Peer Group and how those differences affect the pro forma valuation. Emphasis is placed on the specific strengths and weaknesses of the Holding Company relative to the Peer Group in such key areas as financial condition, profitability, growth and viability of RP Financial, LC. Page 4.3 earnings, asset growth, primary market area, dividends, liquidity of the shares, marketing of the issue, management, and the effect of government regulations and/or regulatory reform. We have also considered the market for thrift stocks, in particular new issues, to assess the impact on value of CSBC coming to market at this time. 1. Financial Condition The financial condition of an institution is an important determinant in pro forma market value, because investors typically look to such factors as liquidity, capital, asset composition and quality, and funding sources in assessing investment attractiveness. The similarities and differences in the Holding Company's and the Peer Group's financial strength are noted as follows: . Overall A/L Composition. Loans funded by retail deposits were the primary components of both CSBC's and the Peer Group's balance sheets. The Peer Group's interest-earning asset composition exhibited a slightly higher concentration of loans, while CSBC's loan portfolio composition exhibited a greater degree of diversification into higher risk and higher yielding types of loans. Overall, the Holding Company's and the Peer Group's asset compositions translated into similar risk weighted assets-to-assets ratios, which both exceeded the comparable ratio for all publicly-traded thrifts. CSBC's funding composition reflected a higher level of deposits and a lower level of borrowings than the comparable Peer Group ratios. Overall, as a percent of assets, the Holding Company maintained a lower level of interest-earning assets and a comparable level of interest-bearing liabilities relative to the Peer Group's measures, which resulted in a higher IEA/IBL ratio for the Peer Group. The infusion of stock proceeds should serve to increase the Holding Company's IEA/IBL ratio to a ratio that is more comparable to the Peer Group's ratio, although the Holding Company will continue to maintain a higher level of non-interest earning assets compared to the Peer Group, which is due in part to the larger impact of goodwill and intangibles on the Holding Company's balance sheet. For valuation purposes, RP Financial concluded that a slight downward adjustment was warranted for the Holding Company's overall asset/liability composition. . Credit Quality. The Holding Company and the Peer Group maintained comparable non-performing assets-to-assets ratios and comparable reserves as a percent of non-performing assets and non-performing loans, while the Holding Company maintained higher loss reserves as a percent of net loans receivable. CSBC and the Peer Group maintained similar risk weighted assets-to-assets ratios and net charge-offs were not a material factor for either CSBC or the Peer Group. RP Financial, LC. Page 4.4 Overall, in comparison to the Peer Group, the Holding Company's measures imply a comparable degree of credit exposure and, thus, RP Financial concluded that no adjustment was warranted for the Holding Company's credit quality. . Balance Sheet Liquidity. The Holding Company operated with a slightly lower level of cash and investment securities relative to the Peer Group (19.4 percent of assets versus 20.4 percent for the Peer Group). Following the infusion of stock proceeds, the Holding Company's cash and investments ratio is expected to increase as the proceeds retained at the Holding Company level are anticipated to be initially deployed into investments. CSBC's future borrowing capacity was considered to be slightly greater than the Peer Group's, in light of the higher level of borrowings currently maintained by the Peer Group. However, both the Holding Company and the Peer Group were considered to have ample borrowing capacities. Overall, balance sheet liquidity for the Holding Company was considered to be comparable to the Peer Group and, thus, RP Financial concluded that no adjustment was warranted for this factor. . Funding Liabilities. Retail deposits served as the primary interest-bearing source of funds for the Holding Company and the Peer Group, with borrowings being utilized to a greater degree by the Peer Group. The Holding Company's overall funding composition provided for a lower cost of funds than maintained by the Peer Group. In total, the Holding Company maintained a similar level of interest-bearing liabilities than the Peer Group. Following the stock offering, the infusion of stock proceeds can be expected to support an increase in the Holding Company's capital ratio and a resulting decline in the level of interest-bearing liabilities maintained as a percent of assets to a ratio that is lower than Peer Group's ratio. Overall, RP Financial concluded that a slight upward adjustment was warranted for CSBC's funding composition. . Capital. The Holding Company operates with a lower pre-conversion capital ratio than the Peer Group, with the gap becoming more significant on a tangible capital basis. After factoring in stock proceeds, the Holding Company's tangible capital position is expected to exceed the Peer Group's ratio. The Holding Company's higher pro forma capital position implies greater leverage capacity, lower dependence on interest-bearing liabilities to fund assets and greater capacity to absorb unanticipated losses. Overall, RP Financial concluded that a slight upward adjustment was warranted for the Holding Company's pro forma capital position. On balance, CSBC's balance sheet strength was considered to be more favorable than the Peer Group's, as implied by the Holding Company's more favorable funding composition and pro forma capital strength. The upward adjustment applied for the Holding Company's balance sheet strength was partially negated by the Peer Group's more favorable overall asset/liability composition. Accordingly, we concluded that a RP Financial, LC. Page 4.5 slight upward valuation adjustment was warranted for the Holding Company's financial condition. 2. Profitability, Growth and Viability of Earnings Earnings are a key factor in determining pro forma market value, as the level and risk characteristics of an institution's earnings stream and the prospects and ability to generate future earnings heavily influence the multiple the investment community will pay for earnings. The major factors considered in the valuation are described below. . Reported Earnings. The Holding Company recorded lower earnings on a ROAA basis (0.65 percent of average assets versus 0.90 percent for the Peer Group). A stronger net interest margin and lower level of operating expenses largely accounted for the Peer Group's more favorable reported earnings. A higher level of net gains was also a factor that contributed to the Peer Group's higher return. A higher level of non-interest operating income, lower loss provisions and a lower effective tax rate represented earnings advantages for the Holding Company. Reinvestment of stock proceeds into interest-earning assets will serve to increase the Holding Company's earnings, with the benefit of reinvesting proceeds expected to be slightly offset by higher operating expenses associated with implementation of the stock benefit plans. The Holding Company's earnings will also benefit from the increase in earnings provided by the acquisition of Innes Street, as the impact of the acquisition is included in only one quarter of the Holding Company's earnings for the twelve months ended March 31, 2002. Overall, after factoring the pro forma impact of the conversion and the acquisition of Innes Street, CSBC's lower reported earnings warranted a slight downward adjustment for valuation purposes. . Core Earnings. Both the Holding Company's and the Peer Group's earnings were derived largely from recurring sources, including net interest income, operating expenses, and non-interest operating income. In these measures, the Holding Company operated with a lower net interest margin, a higher operating expense ratio and a higher level of non-interest operating income. The Holding Company's lower net interest margin and higher level of operating expenses translated into a lower expense coverage ratio (0.99x versus 1.44x for the Peer Group). Likewise, as the result of the Holding Company's lower net interest margin and higher level of operating expenses, the Peer Group's efficiency ratio was more favorable than the Holding Company's (59.6 percent versus 69.5 percent for the Holding Company). Loss provisions had a slightly larger impact on the Peer Group's earnings. Overall, these measures, as well as the expected earnings benefits the Holding Company should realize from the redeployment of stock proceeds into interest-earning assets and the acquisition of Innes Street, RP Financial, LC. Page 4.6 indicated that CSBC's core earnings were not as strong as the Peer Group's and a slight downward adjustment was warranted for the Holding Company's core earnings. . Interest Rate Risk. Quarterly changes in the Holding Company's and the Peer Group's net interest income to average assets ratios indicated a greater degree of volatility in the Holding Company's net interest margin, which was mostly related to the net interest margin impact resulting from the acquisition of Innes Street. Other measures of interest rate risk, such as capital ratios, IEA/IBL ratios, and the level of non-interest earning assets-to-total assets were more favorable for the Peer Group, thereby indicating a lower dependence on the yield-cost spread to sustain net interest income. On a pro forma basis, the Holding Company's capital position and IEA/IBL ratio will be enhanced by the infusion of stock proceeds and should approximate the Peer Group's ratios, although the Holding Company's pro forma ratio of non-interest earning assets will continue to exceed the Peer Group's ratio. Accordingly, RP Financial concluded that a slight downward adjustment was warranted for the higher degree of interest rate risk exposure associated with the Holding Company's earnings. . Credit Risk. Loan loss provisions were a larger factor in the Peer Group's earnings (0.19 percent of average assets versus 0.05 percent for the Holding Company). In terms of future exposure to credit quality related losses, both the Holding Company's and the Peer Group's operating strategies and credit quality measures indicated comparable credit risk exposure. Lending diversification into higher risk types of loans was slightly greater for the Holding Company, while the Peer Group maintained a slightly higher ratio of total loans-to-assets. The Holding Company's and the Peer Group's credit quality measures indicated similar ratios of non-performing assets-to-assets and comparable reserve coverage ratios as a percent of non-performing assets and non-performing loans. The Holding Company maintained slightly higher reserves as a percent of loans receivable. Overall, RP Financial concluded that no adjustment was warranted for this factor. . Earnings Growth Potential. Several factors were considered in assessing earnings growth potential. First, the Holding Company's acquisition of Innes Street will facilitate earnings growth above the earnings growth that will be provided by the lower asset and loan growth measures indicated for Peer Group. Second, following the infusion of stock proceeds, the Holding Company's earnings growth potential with respect to leverage capacity will be greater than the Peer Group's. Lastly, opportunities for lending and deposit growth in the Holding Company's market area are considered to be similar to the primary market areas served by the Peer Group companies in general (see Exhibit III-5). Overall, the Holding Company's earnings growth potential appears to be more favorable than the Peer Group's, and, thus, we concluded that a slight upward adjustment was warranted for this factor. RP Financial, LC. Page 4.7 . Return on Equity. The Holding Company's return on equity will be below the comparable averages for the Peer Group and the industry, owing to CSBC's higher pro forma capital position and lower core earnings. In view of the lower capital growth rate that will be imposed by CSBC's lower ROE, we concluded that a moderate downward adjustment was warranted for the Holding Company's ROE. Overall, in light of the Peer Group's more favorable reported and core earnings, greater interest rate risk exposure and expected lower return on equity, which was partially offset by the Holding Company's more favorable earnings growth potential, RP Financial concluded that a slight downward valuation adjustment was warranted for the Holding Company's profitability, growth and viability of earnings. 3. Asset Growth CSBC's asset growth was significantly higher than the Peer Group's during the period covered in our comparative analysis (65.3 percent growth rate versus 7.8 percent for the Peer Group), which was supported by acquisition related growth. On a pro forma basis, the Holding Company's tangible equity-to-assets ratio is expected to greater than the Peer Group's, resulting in slightly greater leverage capacity for CSBC. The general demographic and competitive nature of the markets served by the Holding Company and the Peer Group are considered to be fairly comparable with respect to opportunities to grow the balance sheet through retail growth. Accordingly, on balance, we believe a slight upward adjustment was warranted for this factor. 4. Primary Market Area The general condition of an institution's market area has an impact on value, as future success is in part dependent upon opportunities for profitable activities in the local market served. Operating in close proximity to Charlotte, the Holding Company faces significant competition for loans and deposits from larger financial institutions, many of which provide a broader array of services and have significantly larger branch networks than maintained by the Holding Company. CSBC's primary market area for deposits and loans is considered to be the Central Piedmont region of North and South Carolina, which includes the North Carolina Counties of Gaston, Rowan, Iredell, Mecklenburg, Cabarrus, Lincoln and Cleveland, and the RP Financial, LC. Page 4.8 South Carolina County of York. In conjunction with the national recession, the regional market served by the Holding Company's experienced an economic slow down, particularly in the manufacturing sector that serves as the basis of the local economy. However, demographic growth trends show favorable population and household growth rates for the market area counties where CSBC maintains a branch presence, particularly in Iredell and Rowan Counties. Per capita and household income measures indicate that the Holding Company operates in a less affluent market area relative to primary market areas served by the Peer Group companies in general. Overall, the markets served by the Peer Group companies were viewed as having favorable growth characteristics. The primary markets served by the Peer Group companies have on average experienced comparable population growth as Gaston County. With the exception of Cook County in Illinois, which includes the City of Chicago, the population sizes of the markets served by the Peer Group companies were also comparable to Gaston County. The median deposit market share maintained by the Peer Group companies was less than the Holding Company's market share of deposits in Gaston County. In general, the degree of competition faced by the Peer Group companies was considered to be comparable to the competitiveness of the Holding Company's primary market area and the growth potential of the markets served by the Peer Group companies was also considered to be not materially different compared to the potential growth opportunities provided by the Holding Company's primary market area. Summary demographic and deposit market share data for the Holding Company and the Peer Group companies is provided in Exhibit III-5. As shown in Table 4.1, April 2002 unemployment rates for the markets served by the Peer Group companies were lower compared to the Gaston County unemployment rate. On balance, we concluded that no adjustment was appropriate for the Holding Company's market area. RP Financial, LC. Page 4.9 Table 4.1 Market Area Unemployment Rates Citizens South Banking Corporation and the Peer Group Companies (1) April 2002 County Unemployment ------ ------------ Citizens South - NC Gaston 7.5% The Peer Group -------------- Acadiana Bancshares - LA Lafayette 3.7% Citizens First Financial - IL McLean 2.5 Community Fin. Corp. - VA Staunton 3.1 Cooperative Bancshares - NC New Hanover 6.1 EFC Bancorp, Inc. - IL Kane 6.3 First Capital, Inc. - IN Harrison 3.7 First Federal Bancshares - AR Boone 5.6 First SecurityFed Financial - IL Cook 6.8 Guaranty Federal Bancshares - MO Greene 3.8 HMN Financial, Inc. - MN Olmsted 3.7 HopFed Bancorp - KY Christian 4.6 LSB Financial Corp. - IN Tippecanoe 3.6 Peoples Community Bancorp - OH Butler 4.2 (1)Unemployment rates are not seasonally adjusted. Source: U.S. Bureau of Labor Statistics. 5. Dividends The Holding Company has indicated its intention to pay an annual cash dividend. At this time, the Holding Company has indicated that the annual dividend payment will approximate $0.20 per share at the midpoint of the valuation range, which would provide for a yield of 2.0 percent based on the $10.00 per share initial offering price. As set forth in the prospectus, the indicated annual dividend would range from $0.23 per share at the minimum of the valuation range to $0.15 per share at the supermaximum of the valuation range. The Holding Company's indicated dividend following the conversion is intended to preserve the current per share dividend amount of $0.32 per share received by the public stockholders, adjusted to reflect the exchange ratio. However, future declarations of dividends by the Board of Directors will depend RP Financial, LC. Page 4.10 upon a number of factors, including investment opportunities, growth objectives, financial condition, profitability, tax considerations, minimum capital requirements, regulatory limitations, stock market characteristics and general economic conditions. Twelve of the 13 Peer Group companies pay regular cash dividends, with implied dividend yields ranging from 1.45 percent to 3.78 percent. The average dividend yield on the stocks of the Peer Group institutions was 2.43 percent as of June 14, 2002, representing an average core earnings payout ratio of 37.79 percent. As of June 14, 2002, approximately 88 percent of all publicly-traded thrifts had adopted cash dividend policies (see Exhibit IV-1) exhibiting an average yield of 2.28 percent and an average payout ratio of 33.67 percent. The dividend paying thrifts generally maintain higher than average profitability ratios, facilitating their ability to pay cash dividends. The Holding Company's indicated dividend provides for a yield and payout ratio that are fairly consistent with the comparable Peer Group averages. Likewise, based on the Holding Company's pro forma earnings and capital, the Holding Company's dividend paying capacity is considered to be comparable to the Peer Group's. On balance, we concluded that no adjustment was warranted for purposes of dividends relative to the Peer Group. 6. Liquidity of the Shares The Peer Group is by definition composed of companies that are traded in the public markets, eleven of the Peer Group members trade on the NASDAQ system and two trade on the AMEX. Typically, the number of shares outstanding and market capitalization provides an indication of how much liquidity there will be in a particular stock. The market capitalization of the Peer Group companies ranged from $26.2 million to $90.6 million as of June 14, 2002, with an average market value of $52.1 million. The shares issued and outstanding to the public shareholders of the Peer Group members ranged from approximately 1.2 million to 4.6 million, with average shares outstanding of approximately 2.9 million. The Holding Company's pro forma market value is expected to be comparable to the Peer Group's average market capitalization, while CSBC's pro forma shares outstanding should be at the high end of the range of shares outstanding maintained by the Peer Group companies. It is anticipated that the Holding RP Financial, LC. Page 4.11 Company's stock will be quoted on the NASDAQ National Market System. Overall, we anticipate that the Holding Company's stock will have a comparable trading market as the Peer Group companies on average and, therefore, concluded no adjustment was necessary for this factor. 7. Marketing of the Issue We believe that four separate markets need to be considered for thrift stocks such as CSBC coming to market: (1) the after-market for public companies, in which trading activity is regular and investment decisions are made based upon financial condition, earnings, capital, ROE, dividends and future prospects; (2) the new issue market in which converting thrifts are evaluated on the basis of the same factors, but on a pro forma basis without the benefit of prior operations as a fully-converted publicly-held company; (3) the thrift acquisition market for thrift franchises in North Carolina; and (4) the market for the public stock of CSBC. All of these markets were considered in the valuation of the Holding Company's to-be-issued stock. A. The Public Market The value of publicly-traded thrift stocks is easily measurable, and is tracked by most investment houses and related organizations. Exhibit IV-1 provides pricing and financial data on all publicly-traded thrifts. In general, thrift stock values react to market stimuli such as interest rates, inflation, perceived industry health, projected rates of economic growth, regulatory issues and stock market conditions in general. Exhibit IV-2 displays historical stock market trends for various indices and includes historical stock price index values for thrifts and commercial banks. Exhibit IV-3 displays historical stock price indices for thrifts only. In terms of assessing general stock market conditions, the performance of the overall stock market has been mixed over the past year. As the result of profit warnings and growing concerns about the corporate earnings outlook, stocks moved lower in mid-June 2001. Technology stocks experienced the most significant selling pressure, as evidenced by a seven-day losing streak in the NASDAQ from June 8 through June 18, 2001. Speculation of another rate cut by the Federal Reserve at its late-June meeting provided for a relatively flat market RP Financial, LC. Page 4.12 ahead of the policy meeting. Stocks reacted mildly to the 0.25 percent rate cut implemented by the Federal Reserve in late-June and continued to trade in a narrow range to close out the second quarter. Generally weak second quarter earnings and growing uncertainty of an economic recovery in the second half of the year combined to pull stocks lower during most of July. Weak economic data and more bad earnings news from the technology sector continued to pressure stocks lower during the first half of August 2001. The Federal Reserve's 0.25 percent rate cut at its mid-August meeting did little to lift the sagging stock market, as stocks tumbled sharply on the Federal Reserve's gloomy outlook for the economy. News that consumer confidence declined for the second month in a row in August and second quarter GDP growth of 0.2 percent was the slowest growth in eight years served to sharpen the sell-off in late August, reflecting growing pessimism about the chances of a near term economic recovery. The stock market continued to slump in early-September, as the sharp increase in August unemployment sparked a broad-based sell-off. On September 11, 2001, all major financial markets closed in the wake of the terrorist attack on the World Trade Center and remained closed for the balance of the week. Prior to the resumption of trading on September 17, 2001, the Federal Reserve cut short-term rates by 0.50 percent as an attempt to provide support to the stock market. However, stocks sank sharply in the first day of trading after the terrorist attack, with some of the most significant losses occurring in the airline, travel and insurance stocks. Fears over an extended war on terrorism and further erosion of the nation's weakening economy extended the sell-off through the remainder of the week, as blue chip stocks posted their biggest weekly loss since the Depression. For the week ended September 21, 2001, the Dow Jones Industrial Average ("DJIA") dropped nearly 1,370 points or 14.3 percent. On September 24, 2001, stocks posted their first gains since the terrorist attack, as the DJIA regained approximately 25 percent of the prior week's losses with a one-day increase in the average of 368 points or 4.5 percent. Stocks continued to rebound through the end of September, regaining approximately half of the decline recorded in the first week of trading following the terrorist attack. The positive trend in the broader stock market generally prevailed through most of October 2001, despite a continuation of bad economic news. Growing confidence about the RP Financial, LC. Page 4.13 U.S. military attack in Afghanistan and hopes for a turnaround in the economy were factors that contributed to the stock market recovery. Stocks retreated in late-October, amid uncertainties about the job market and a decline in consumer confidence. Anticipation of another rate cut by the Federal Reserve served to lift stocks in early-November and the rally strengthened following the Federal Reserve's implementation of another half point rate cut at its regularly scheduled meeting in early-November. The favorable trend in the broader stock market continued through most of November, as the DJIA achieved a technical definition of a bull market in the third week of November and closed just shy of 10000 at month's end. In early-December 2001, technology stocks surged higher and the DJIA surpassed the 10000 mark, reflecting growing optimism about an economic recovery. However, the stock market rally ended on news of a larger than expected increase in the November unemployment rate. Fresh concerns about the corporate earnings outlook pushed stocks lower in mid-December, despite the Federal Reserve's eleventh interest rate cut of the year. During the second half of December, stocks generally moved higher on year end buying and favorable economic data that showed surprisingly strong new home construction. Notwithstanding the year end rally, the DJIA closed seven percent lower for the year and the NASDAQ Composite Index declined 21 percent in 2001, providing for the worst two-year performance in the stock market in 23 years. The stock market began 2002 with a New Year's rally, as investors bet on a forthcoming economic recovery and an upturn in corporate earnings. The momentum of the advance faded in mid-January, reflecting concerns that the markets were pricing in more of a recovery than the economy was showing. The Federal Reserve's decision to leave interest rates unchanged and indications that the economic downturn may be ending provided for a brief rebound in the broader stock market at the end of January. Stock market activity was mixed throughout most of February, as fears that accounting troubles similar to those impacting Enron could affect more companies weighed against hopes for an economic recovery and improved corporate earnings. The DJIA moved back above 10000 in late-February and sustained upward momentum in early-March, as favorable economic news and the Federal Reserve's cautiously optimistic assessment of the economy served to rally the broader market. Stocks traded in a narrow range in mid-March, reflecting uncertainty over the strength of the economic recovery RP Financial, LC. Page 4.14 and the possibility of future rate increases by the Federal Reserve. The Federal Reserve's decision to leave short-term rates unchanged at its mid-March meeting, as well as a shift in its policy directive to a neutral stance from one that favored additional easing, provided for a mixed reaction in the stock market. Stocks moved lower in late-March, reflecting first quarter earnings concerns and the prospect of rising interest rates. The general stock market declined at the beginning of the second quarter of 2002, reflecting growing concerns about the Mideast conflict. The broader stock market continued to struggle through mid-April, as the result of disappointing first quarter earnings among some of the blue chip stocks and weak earnings forecasts for the balance of 2002. Stocks continued to falter into late-April, primarily on the basis of weak first quarter earnings and growing concerns about the strength of the economic recovery. The extended sell-off prompted a rebound in blue-chip stocks at the end of April, but the rally sputtered on news of a sharper than expected increase in the April unemployment rate. The April 2002 unemployment rate rose to 6.0 percent, its highest level in nearly eight years. Stocks were largely unchanged by the Federal Reserve's widely anticipated decision to leave rates unchanged at its early-May 2002 meeting, but then rallied sharply higher the day following the meeting on hints from Cisco about a possible business rebound. Favorable economic data in the form of stronger than expected retail sales in April and rising hopes of more upbeat earnings forecast by technology firms supported further advances in stocks during mid-May. The rebound was not sustained in late-May, as profit taking and more terrorism warnings dampened investor enthusiasm for stocks. Market pessimism extended the sell-off in stocks in early-June, reflecting political turmoil abroad, concerns over corporate scandals and more disappointing earnings news from market leaders. As an indication of the general trends in the nation's stock markets over the past year, as of June 14, 2002, the DJIA closed at 9474.21 a decline of 10.8 percent from one year earlier, while the NASDAQ Composite Index stood at 1504.74, a decline of 25.8 percent over the same time period. The Standard & Poors 500 Index closed at 1007.27 on June 14, 2002, a decline of 17.1 percent from a year ago. The market for thrift stocks has been mixed during the past twelve months, but, in general, thrift stocks have outperformed the broader market. Expectations of further rate cuts by RP Financial, LC. Page 4.15 the Federal Reserve and stronger second quarter earnings translated into slightly higher thrift prices in early-June 2001. Consolidation among thrift stocks, including Washington Mutual's proposed $5.2 billion acquisition of Dime Bancorp, extended the rally in thrift issues through mid-June. The widely anticipated rate cut by the Federal Reserve at its late-June meeting had little impact on thrift prices, as thrift prices eased lower at the close of the second quarter on profit taking. Generally favorable second quarter earnings realized from strong lending volumes and expansion of the net interest margin served to boost thrift prices during July, in which the strongest gains were again posted by the large-cap issues. The positive trend in thrift stocks continued to prevail during the first half of August 2001, reflecting a continuation of the favorable interest rate environment and little threat of inflationary pressures. Thrift stocks reacted mildly to the widely anticipated 0.25 percent rate cut by the Federal Reserve in mid-August, which was followed a decline of more than 5.0 percent in the SNL Index for all publicly-traded thrifts in late-August. The decline in the market-cap weighted SNL Index was prompted by news that some of the large publicly-traded thrift lenders were experiencing net interest margin compression. Thrift stocks followed the broader market lower in early-September, reflecting the potential negative implications that a slowdown in consumer spending would have on financial stocks. In a sharp contrast to the broader market, thrift stocks moved higher on the first day of trading following the terrorist attack. The increase in thrift stocks was attributed to the 0.50 percent rate cut implemented by the Federal Reserve, which provided for a further steepening of the yield curve, and large buyback programs announced by a number of the large-cap thrifts following the Securities and Exchange Commission's decision to waive many of the regulations governing repurchases. However, thrift stocks experienced selling pressure at the end of the week ended September 21, 2001, as investors became wary that the worsening U.S. economy would negatively impact the housing market and related industries as well. Oversold conditions in the thrift sector provided for a positive correction in thrift stocks at the close of September. Thrift stocks eased lower through mid-October 2001, reflecting expectations that the series of interest rate cuts implemented by the Federal Reserve would be ending soon and the RP Financial, LC. Page 4.16 slowing economy would also began to negatively impact residential lenders. The SNL Index dropped sharply in mid-October, as third quarter results for two large-cap issues (Washington Mutual and Golden West Financial) indicated an increase in problem assets. After trading in a narrow range through the balance of October, thrifts stocks rebounded during most of November. Attractive valuations on some of the large-cap issues that had become oversold and another rate cut by the Federal Reserve in early-November were factors that contributed to the recovery in thrift prices. Thrift stocks eased lower at the close of November and traded in a narrow range in early-December, which was largely attributed to profit taking in some of the large-cap issues following their strong November performance. Expectations that earnings would benefit from the additional interest rate cuts implemented by the Federal Reserve during the fourth quarter supported an upward trend in thrift issues during mid- and late-December. For the year ended 2001, the SNL Index for all publicly-traded thrifts posted a gain of 5.0 percent. Further gains were registered in thrift stocks at the beginning of 2002, with the strongest performances again turned in by the larger companies. Expectations of strong fourth quarter earnings and growing sentiment of a slow economic recovery that would support a continuation of the steep yield curve were factors that contributed to the advance in thrift stocks. Thrift issues stabilized in mid-January and then moved higher in late-January, as investors were encouraged by fourth quarter earnings. In early-February, concerns about corporate accounting practices spilled over into the financial services sector, which translated into a general decline in bank and thrift stocks, particularly the large-cap issues. After stabilizing in mid-February, thrift issues advanced in late-February and early-March on strong fundamentals and acquisition speculation. Thrift stocks edged lower following the Federal Reserve meeting in March, reflecting growing sentiment that the economic recovery would lead to higher interest rates in the second half of the year. Thrift issues moved higher in early-April 2002, as investors became more optimistic about first and second quarter earnings for the thrift sector. Growing sentiment that the Federal Reserve would not raise rates in May further contributed to the upswing in thrift prices. The upward momentum in thrift stocks was sustained through mid-April, with the advance supported by favorable first quarter earnings, low inflation data and investors dumping technology stocks in favor of lower risk bank and thrift stocks. Thrift stocks stabilized in late- RP Financial, LC. Page 4.17 April in the face of a downturn experienced in broader stock market, as traditional spread lenders benefited from generally weak economic news. News of the increase in the April unemployment rate served to boost thrift prices in early-May, as the weak employment data lessened expectations of a strong economic recovery that could lead to higher interest rates. Thrift stocks stabilized in mid- and late- May, as Citigroup's proposed $5.8 billion acquisition of Golden State Bancorp had little impact on the broader thrift market. While the broader market experienced extensive selling pressure in early-June, the decline in thrift issues was relatively mild as investors continued to be attracted to the generally more stable performance characteristics of thrift stocks. On June 14, 2002, the SNL Index for all publicly-traded thrifts closed at 1,105.8, an increase of 17.7 percent from one year ago. B. The New Issue Market In addition to thrift stock market conditions in general, the new issue market for converting thrifts is also an important consideration in determining the Holding Company's pro forma market value. The new issue market is separate and distinct from the market for seasoned stock thrifts in that the pricing ratios for converting issues are computed on a pro forma basis, specifically: (1) the numerator and denominator are both impacted by the conversion offering amount, unlike existing stock issues in which price change affects only the numerator; and (2) the pro forma pricing ratio incorporates assumptions regarding source and use of proceeds, effective tax rates, stock plan purchases, etc. which impact pro forma financials, whereas pricing for existing issues are based on reported financials. The distinction between pricing of converting and existing issues is perhaps no clearer than in the case of the price/tangible book ("P/TB") ratio in that the P/TB ratio of a converting thrift will typically result in a discount to tangible book value whereas in the current market for existing thrifts the P/TB ratio often reflects a premium to tangible book value. Therefore, it is appropriate to also consider the market for new issues, both at the time of the conversion and in the aftermarket. The market for converting thrifts has strengthened in conjunction with the broader thrift market over the past year, although conversion activity has remained somewhat limited. As shown in Table 4.2, only one standard conversion offering has been completed during the past three months. The average pro forma price/tangible book and core price/earnings ratios of RP Financial, LC. Page 4.18 (table omitted) RP Financial, LC. Page 4.19 the recent standard conversion equaled 64.9 percent and 17.4 times, respectively. One second-step conversion offering, Willow Grove Bancorp of Pennsylvania ("Willow Grove"), has also been completed during the past three months, which is considered to be more relevant for purposes of determining CSBC's pro forma pricing. The average pro forma price/tangible book and core price/earnings ratios of Willow Grove equaled 96.6 percent and 24.1 times, respectively. In general, second-step conversions tend to be priced (and trade in the aftermarket) at a higher P/TB ratio than standard conversions. We believe investors take into consideration the generally more leveraged pro forma balance sheets of second-step companies, their track records as public companies prior to conversion, and their generally higher pro forma ROE measures relative to standard conversions in pricing their common stocks. Exhibit IV-4 presents historical offering data for second-step conversions, illustrating the historical trends and characteristics of second-step offerings. Shown in Table 4.3 are the current pricing characteristics of Willow Grove, which is the only NASDAQ or Exchange listed full conversion offering that has been completed during last three months. Willow Grove's current P/TB ratio of 110.33 percent reflects a discount of 22.7 percent from the average P/TB ratio of all publicly-traded thrifts (equal to 142.69 percent) and Willow Grove's core P/E ratio of 27.21 times reflects a premium of 60.3 percent from the average core P/E ratio of 16.97 times for all publicly-traded thrifts. Overall, the pricing ratios of Willow Grove suggest that the investment community has determined to discount its stock on a book basis until the earnings improve through redeployment and leveraging of the proceeds over the longer term. C. The Acquisition Market Also considered in the valuation was the potential impact on CSBC's stock price of recently completed and pending acquisitions of other savings institutions operating in North Carolina. As shown in Exhibit IV-5, there were sixteen acquisitions of North Carolina savings institutions completed between 1998 through year-to-date 2002 and there are currently no pending acquisitions of North Carolina savings institutions. The recent acquisition activity involving North Carolina savings institutions may imply a certain degree of acquisition speculation for the Holding Company's stock. To the extent that acquisition speculation may RP FINANCIAL, LC. Financial Services Industry Consultants 1700 North Moore Street, Suite 2210 Arlington, Virginia 22209 (703) 528-1700 Page 4.20 (table omitted) RP Financial, LC. Page 4.21 impact the Holding Company's offering, we have largely taken this into account in selecting companies which operate in markets that have experienced a comparable level of acquisition activity as the Holding Company's market and, thus, are subject to the same type of acquisition speculation that may influence CSBC's trading price. D. Trading in CSBC's Stock Since CSBC's minority stock currently trades under the symbol "CSBC" on the NASDAQ National Market System, RP Financial also considered the recent trading activity in the valuation analysis. CSBC had a total of 4,209,434 shares issued and outstanding at March 31, 2002, of which 1,752,427 were held by public shareholders and were traded as public securities. As of June 14, 2002, the Holding Company's closing stock price was $20.00 per share. There are significant differences between the Holding Company's minority stock (currently being traded) and the conversion stock that will be issued by the Holding Company. Such differences include different liquidity characteristics (the new conversion stock will be more liquid owing to larger number of public shares available to trade), a different return on equity for the conversion stock and dividend payments will be made on all shares outstanding; thereby, requiring a higher payout ratio to sustain the current level of dividends paid to non-MHC shareholders. Since the pro forma impact has not been publicly disseminated to date, it is appropriate to discount the current trading level. As the pro forma impact is made known publicly, the trading level will become more informative. * * * * * * * * * * * In determining our valuation adjustment for marketing of the issue, we considered trends in both the overall thrift market, the new issue market including the new issue market for second-step conversions, the acquisition market and recent trading activity in the Holding Company's minority stock. Taking these factors and trends into account, RP Financial concluded that no adjustment was appropriate in the valuation analysis for purposes of marketing of the issue. RP Financial, LC. Page 4.22 8. Management CSBC's management team appears to have experience and expertise in all of the key areas of the Holding Company's operations. Exhibit IV-6 provides summary resumes of CSBC's Board of Directors and senior management. Based upon our due diligence conducted of the Holding Company and the Holding Company's financial characteristics, the Holding Company is viewed as being effectively managed and there appears to be a well-defined organizational structure. Similarly, the returns, capital positions, and other operating measures of the Peer Group companies are indicative of well-managed financial institutions, which have Boards and management teams that have been effective in implementing competitive operating strategies. Therefore, on balance, we concluded no valuation adjustment relative to the Peer Group was appropriate for this factor. 9. Effect of Government Regulation and Regulatory Reform In summary, as a fully-converted SAIF-insured institution, CSBC and the Holding Company will operate in substantially the same regulatory environment as the Peer Group members -- all of whom are adequately capitalized institutions and are operating with no apparent restrictions. Exhibit IV-7 reflects the Bank's pro forma regulatory capital ratios. On balance, no adjustment has been applied for the effect of government regulation and regulatory reform. Summary of Adjustments Overall, based on the factors discussed above, we concluded that the Holding Company's pro forma market value should reflect the following valuation adjustments relative to the Peer Group: Key Valuation Parameters: Valuation Adjustment ------------------------ -------------------- Financial Condition Slight Upward Profitability, Growth and Viability of Earnings Slight Downward Asset Growth Slight Upward Primary Market Area No Adjustment RP Financial, LC. Page 4.23 Key Valuation Parameters: Valuation Adjustment ------------------------ -------------------- Dividends No Adjustment Liquidity of the Shares No Adjustment Marketing of the Issue No Adjustment Management No Adjustment Effect of Government Regulations and Regulatory Reform No Adjustment Valuation Approaches In applying the accepted valuation methodology promulgated by the OTS and adopted by the FDIC, i.e., the pro forma market value approach, including the fully-converted analysis described above, we considered the three key pricing ratios in valuing CSBC's shares' to-be-issued stock -- price/earnings ("P/E"), price/book ("P/B"), and price/assets ("P/A") approaches -- all performed on a pro forma basis including the effects of the conversion proceeds. In computing the pro forma impact of the conversion and the related pricing ratios, we have incorporated the valuation parameters disclosed in CSBC's prospectus for reinvestment rate, the effective tax rate, offering expenses and stock benefit plan assumptions (summarized in Exhibits IV-8 and IV-9). In our estimate of value, we assessed the relationship of the pro forma pricing ratios relative to the Peer Group, and the recent conversions including second-step conversion offerings. RP Financial's valuation placed an emphasis on the following: . P/E Approach. The P/E approach is generally the best indicator of long-term value for a stock. Given the similarities between the Holding Company's and the Peer Group's earnings composition and overall financial condition, the P/E approach was carefully considered in this valuation. At the same time, since reported earnings for both the Holding Company and the Peer Group included certain non-recurring items, we also made adjustments to earnings to arrive at core earnings estimates for Holding Company and the Peer Group and resulting price/core earnings ratios. . P/B Approach. P/B ratios have generally served as a useful benchmark in the valuation of thrift stocks, particularly in the context of conversion offerings, as the earnings approach involves assumptions regarding the use of proceeds. RP Financial considered the P/B approach to be a valuable indicator of pro forma value taking into account the pricing ratios under the P/E and P/A approaches. We have also modified the P/B approach to exclude the impact of intangible RP Financial, LC. Page 4.24 assets (i.e., price/tangible book value or "P/TB"), in that the investment community frequently makes this adjustment in its evaluation of this pricing approach. . P/A Approach. P/A ratios are generally a less reliable indicator of market value, as investors typically assign less weight to assets and attribute greater weight to book value and earnings - we have also given less weight to the assets approach. Furthermore, this approach as set forth in the regulatory valuation guidelines does not take into account the amount of stock purchases funded by deposit withdrawals, thus understating the pro forma P/A ratio. At the same time, the P/A ratio is an indicator of franchise value, and, in the case of highly capitalized institutions, high P/A ratios may limit the investment community's willingness to pay market multiples for earnings or book value when ROE is expected to be low. . Trading of CSBC stock. Converting institutions generally do not have stock outstanding. CSBC, however, has public shares outstanding due to the mutual holding company form of ownership. Since CSBC is currently traded on the NASDAQ, it is an indicator of investor interest in the Holding Company's conversion stock and therefore received some weight in our valuation. Based on the June 14, 2002 stock price of $20.00 per share and the 4,209,434 shares of Holding Company stock issued and outstanding, the implied value of $84 million was considered in the valuation process. However, since the conversion stock will have different characteristics than the minority shares, and since pro forma information has not been publicly disseminated to date, the current trading price of CSBC was somewhat discounted herein but will become more important towards the closing of the offering. The Holding Company had adopted Statement of Position ("SOP") 93-6, which causes earnings per share computations to be based on shares issued and outstanding excluding unreleased ESOP shares. For purposes of preparing the pro forma pricing analyses, we have reflected all shares issued in the offering, including all ESOP shares, to capture the full dilutive impact, particularly since the ESOP shares are economically dilutive, receive dividends and can be voted. However, we did consider the impact of the adoption of SOP 93-6 in the valuation. Based on the application of the three valuation approaches, taking into consideration the valuation adjustments discussed above, RP Financial concluded that, as of June 14, 2002, the aggregate pro forma market value of CSBC's conversion stock was $68,529,460 at the midpoint, equal to 6,852,946 shares at $10.00 per share. The midpoint and resulting valuation range is based on the sale of a 58.37 percent ownership interest to the public, which provides for a $40.0 million public offering at the midpoint value. RP Financial, LC. Page 4.25 1. Price-to-Earnings ("P/E"). The application of the P/E valuation method requires calculating the Holding Company's pro forma market value by applying a valuation P/E multiple to the pro forma earnings base. In applying this technique, we considered both reported earnings and a recurring earnings base, that is, earnings adjusted to exclude any one-time non-operating items, plus the estimated after-tax earnings benefit of the reinvestment of the net proceeds. The Holding Company's reported earnings, incorporating reinvestment of $19,000 of MHC assets at an after-tax reinvestment rate of 2.79 percent, equaled $2.185 million for the twelve months ended March 31, 2002. In deriving CSBC's core earnings, the only adjustment made to reported earnings was to eliminate the gains and losses on sale of assets. For the twelve month period, the Holding Company recorded net gains of $87,000 on the sale of assets. As shown below, on a tax effected basis, assuming an effective marginal tax rate of 36.0 percent for the loss eliminated, the Holding Company's core earnings were determined to equal $2.129 million for the twelve months ended March 31, 2002. (Note: see Exhibit IV-10 for the adjustments applied to the Peer Group's earnings in the calculation of core earnings). Amount ($000) Net income $ 2,185 Net gains on sale of loans(1) (56) ------- Core earnings estimate $ 2,129 (1) Tax effected at 36.0 percent. Based on the Holding Company's reported and estimated core earnings, and incorporating the impact of the pro forma assumptions discussed previously, the Holding Company's pro forma reported and core P/E multiples at the $68.5 million midpoint value equaled 22.40 times and 22.82 times, respectively, which provided for premiums of 58.9 percent and 42.4 percent relative to the Peer Group's average reported and core earnings multiples of 14.10 times and 16.02 times, respectively (see Table 4.4). The implied premiums reflected in the Holding Company's pro forma P/E multiples take into consideration the discount implied for the Holding Company's pro forma P/B ratio, as well as the pro forma increase in earnings that will be realized from the acquisition of Innes Street and is not currently fully reflected in the Holding Company's trailing twelve month earnings. The Holding Company's trailing twelve month RP FINANCIAL, LC. - ---------------------------------------- Financial Service Industry Consultants 1700 North Moore Street, Suite 2210 Arlington, Virginia 22209 (703) 528-1700 Table 4.4 Public Market Pricing Citizens South Banking Corp. and the Comparibles As of June 14, 2002 RP Financial, LC. Page 4.27 earnings for the period ended March 31, 2002 includes only one quarter of earnings following the acquisition of Innes Street. 2. Price-to-Book ("P/B"). The application of the P/B valuation method requires calculating the Holding Company's pro forma market value by applying a valuation P/B ratio to CSBC's pro forma book value. The Holding Company's pre-conversion book value was adjusted to include $19,000 of equity held at the MHC level, which will be consolidated with the Holding Company's capital as a result of the conversion. Based on the $68.5 million midpoint valuation, CSBC's pro forma P/B and P/TB ratios equaled 87.00 percent and 97.83 percent, respectively. In comparison to the average P/B and P/TB ratios for the Peer Group of 112.84 percent and 113.95 percent, the Holding Company's ratios reflected a discount of 22.9 percent on a P/B basis and a discount of 14.1 percent on a P/TB basis. RP Financial considered the discounts under the P/B approach to be reasonable in light of the valuation adjustments referenced earlier, the Holding Company's resulting premium P/E multiples and lower return on equity. 3. Price-to-Assets ("P/A"). The P/A valuation methodology determines market value by applying a valuation P/A ratio to the Holding Company's pro forma asset base, conservatively assuming no deposit withdrawals are made to fund stock purchases. In all likelihood there will be deposit withdrawals, which results in understating the pro forma P/A ratio which is computed herein. At the midpoint of the valuation range, CSBC's value equaled 14.28 percent of pro forma assets. Comparatively, the Peer Group companies exhibited an average P/A ratio of 11.93 percent, which implies a 19.6 percent premium has been applied to the Holding Company's pro forma P/A ratio. Comparison to Recent Conversions and Second-Step Offerings As indicated at the beginning of this chapter, RP Financial's analysis of recent standard conversion and second-step offering pricing characteristics at closing and in the aftermarket has been limited to a "technical" analysis and, thus, the pricing characteristics of recent standard conversions and second-step offerings are not the primary determinate of value herein. Particular focus was placed on the P/TB approach in this analysis, since the P/E multiples do not RP Financial, LC. Page 4.28 reflect the actual impact of reinvestment and the source of the stock proceeds (i.e., external funds vs. deposit withdrawals). The one standard conversion offering completed within the past three months closed at an average P/TB ratio of 64.9 percent and appreciated 28.0 percent during the first week of trading. The one recently completed second-step conversion offering closed at a price/tangible book ratio of 96.6 percent and its trading price increased 15.5 percent during its first week of trading as a fully converted company. In comparison, the Holding Company's P/TB ratio of 97.8 percent at the midpoint value reflects an implied premium of 1.2 percent relative to the closing P/TB ratio of Willow Grove's recent second-step conversion offering. In comparison to Willow Grove's current aftermarket P/TB ratio of 110.3 percent, the Holding Company's P/TB ratio at the midpoint value reflects an implied discount of 11.3 percent and at the top of the super range reflects an implied premium of 0.2 percent. Valuation Conclusion Based on the foregoing, it is our opinion that, as of June 14, 2002, the estimated aggregate pro forma market value of the Holding Company, inclusive of the sale of the MHC's ownership interest to the public shareholders was $68,529,460 at the midpoint. Based on this valuation and the approximate 58.37 ownership interest being sold in the public offering, the midpoint value of the Holding Company's stock offering was $40,000,000, equal to 4,000,000 shares at a per share value of $10.00. Pursuant to conversion guidelines, the 15 percent offering range indicates a minimum value of $34,000,000 and a maximum value of $46,000,000. Based on the $10.00 per share offering price, this valuation range equates to an offering of 3,400,000 shares at the minimum and 4,600,000 shares at the maximum. In the event the appraised value is subject to an increase, the offering range may be increased up to a supermaximum value of $52,900,000 without requiring a resolicitation. Based on the $10.00 per share offering price, the supermaximum value would result in an offering of 5,290,000 shares. The pro forma valuation calculations relative to the Peer Group are shown in Table 4.4 and are detailed in Exhibit IV-8 and Exhibit IV-9. RP Financial, LC. Page 4.29 Establishment of the Exchange Ratio OTS regulations provide that in a conversion of a mutual holding company, the minority stockholders are entitled to exchange their shares of the Holding Company's common stock for newly issued shares of CSBC as a fully converted company. The Board of Directors of Citizens South Holdings, MHC has independently determined the exchange ratio. The determined exchange ratio has been designed to preserve the current aggregate public ownership percentage in CSBC equal to 41.63 percent as of March 31, 2002. The exchange ratio to be received by the existing minority shareholders of CSBC will be determined at the end of the offering, based on the total number of shares sold in the Subscription and Community offerings. As shown in Table 4.4, the exchange ratio for the minority shareholders would be 1.3838 shares, 1.6280 shares, 1.8722 shares and 2.1530 shares at the minimum, midpoint, maximum and supermaximum of the offering range, respectively. RP Financial expresses no opinion on the proposed exchange of newly issued Holding Company shares for the shares held by the minority stockholders or on the proposed exchange ratio. EX-99.5 15 dex995.txt EXHIBIT 99.5 EXHIBIT 99.5 Exhibit 99.5 RP FINANCIAL, LC. - ------------------------------------------------- Financial Services Industry Consultants May 22, 2002 Mr. Kim Stuart Price President and Chief Executive Officer Citizens South Banking Corporation 245 West Main Avenue Gastonia, North Carolina 28052 Dear Mr. Price: This letter sets forth the agreement between Citizens South Banking Corporation ("Citizens South" or the "Company"), subsidiary of Citizens South Holdings, MHC, Gastonia, North Carolina (the "MHC"), and RP Financial, LC. ("RP Financial"), whereby the Company has engaged RP Financial to prepare the written document and financial projections reflecting the pro forma impact of the mutual to stock conversion of the MHC and the post-conversion activities of the Company. These services are described in greater detail below. Description of Proposed Services RP Financial's business planning services will include the following areas: (1) determining the Company's current financial and operating condition, business strategies and anticipated future strategies, both currently and on a pro forma basis; (2) quantifying the impact of business strategies, incorporating the use of offering proceeds; (3) preparing detailed financial projections on a quarterly basis for a period of at least three fiscal years to reflect the impact of selected business strategies and the use of offering proceeds; (4) preparing the written business plan document which conforms with applicable regulatory guidelines, including a description of the use of offering proceeds and how the convenience and needs of the community will be addressed; and (5) preparing the detailed schedules of the capitalization and inter-company cash flows. Contents of the business plan will include: Philosophy/Goals; Economic Environment and Background; Lending, Leasing and Investment Activities; Deposit, Savings and Borrowing Activity; Asset and Liability Management; Operations; Records, Systems and Controls; Growth, Profitability and Capital; Responsibility for Monitoring this Plan. RP Financial agrees to prepare the business plan and accompanying financial projections in writing such that the business plan conforming to regulatory guidelines can be filed with the appropriate federal and state regulatory agencies in conjunction with the filing of the stock offering application. - -------------------------------------------------------------------------------- Washington Headquarters Rosslyn Center Telephone: (703) 528-1700 1700 North Moore Street, Suite 2210 Fax No.: (703) 528-1788 Arlington, VA 22209 Toll-Free No.: (866) 723-0594 www.rpfinancial.com E-Mail: wpommerening@rpfinancial.com Mr. Kim Stuart Price May 22, 2002 Page 2 Fee Structure and Payment Schedule The Company agrees to compensate RP Financial for preparation of the business plan on a fixed fee basis of $10,000. Payment of the professional fees shall be made upon delivery of the completed business plan. The Company also agrees to reimburse RP Financial for those direct reasonable out-of-pocket expenses necessary and incidental to providing the business planning services. Reimbursable expenses will likely include shipping, telephone/facsimile printing, computer and data services, and shall be paid to RP Financial as incurred and billed. RP Financial will agree to limit reimbursable expenses in conjunction with the business planning and appraisal engagements to $7,500, subject to written authorization from the Company to exceed such level. In the event the Company shall, for any reason, discontinue this planning engagement prior to delivery of the completed business plan and payment of the progress payment fee, the Company agrees to compensate RP Financial according to RP Financial's standard billing rates for consulting services based on accumulated and verifiable time expenses, not to exceed the fixed fee described above, plus reimbursable expenses incurred. If during the course of the planning engagement, unforeseen events occur so as to materially change the nature or the work content of the business planning services described in this contract, the terms of said contract shall be subject to renegotiation by the Company and RP Financial. Such unforeseen events may include changes in regulatory requirements as it specifically relates to the Company. Indemnifications The provisions of paragraph 3 in that certain letter agreement dated May 22, 2002 between the Company and RP Financial are incorporated herein by reference. Please acknowledge your agreement to the foregoing by signing as indicated below and returning to RP Financial a signed copy of this letter. Sincerely, /s/ William E. Pommerening -------------------------------------- William E. Pommerening Chief Executive Officer and Managing Director Agreed To and Accepted By: /s/ Kim S. Price -------------------------------------- Kim Stuart Price President and Chief Executive Officer Upon Authorization by the Board of Directors For: Citizens South Banking Corporation Subsidiary of Citizens South Holdings, MHC Gastonia, North Carolina Date Executed: 5-30-02 --------------- EX-99.6 16 dex996.txt EXHIBIT 99.6 EXHIBIT 99.6 Exhibit 99.6 Citizens South Banking Corporation 245 West Main Avenue Gastonia, North Carolina 28053 (704) 868-5200 NOTICE OF SPECIAL MEETING OF STOCKHOLDERS To Be Held On September __, 2002 Notice is hereby given that the Special Meeting of Stockholders ("Meeting") of Citizens South Banking Corporation (the "Company") will be held at The City Club of Gastonia, 532 South New Hope Road, Gastonia, North Carolina, at __:__ _.m., North Carolina Time, on September __, 2002. As of the date hereof, the Company owns 100% of the common stock of Citizens South Bank (the "Bank") and is majority-owned by Citizens South Holdings, MHC (the "Mutual Holding Company"). A Proxy Statement and Proxy Card for the Meeting are enclosed. The Meeting is for the purpose of considering and acting upon: 1. A plan of conversion and reorganization (the "Plan") pursuant to which the Mutual Holding Company will be merged into the Bank, and the Company will be succeeded by a new Delaware corporation with the same name as the Company which has been established for the purpose of completing the conversion. As part of the conversion and reorganization, shares of common stock representing the Mutual Holding Company's ownership interest in the Company will be offered for sale in a subscription and community offering. Common stock of the Company currently held by public stockholders will be converted into new shares pursuant to an exchange ratio that will ensure that stockholders at the time of the conversion will own the same percentage of Citizens South Banking Corporation after the conversion as was held immediately prior thereto, exclusive of any shares purchased by the stockholder in the offering and cash received in lieu of fractional shares; and such other matters as may properly come before the Meeting, or any adjournments thereof. The Board of Directors is not aware of any other business to come before the Meeting. Any action may be taken on the foregoing proposal at the Meeting on the date specified above, or on any date or dates to which by original or later adjournment the Meeting may be adjourned. Stockholders of record at the close of business on August __, 2002 are the stockholders entitled to vote at the Meeting, and any adjournments thereof. EACH STOCKHOLDER, WHETHER HE OR SHE PLANS TO ATTEND THE MEETING, IS REQUESTED TO SIGN, DATE, AND RETURN THE ENCLOSED PROXY CARD WITHOUT DELAY IN THE ENCLOSED POSTAGE-PAID ENVELOPE. ANY PROXY GIVEN BY THE STOCKHOLDER MAY BE REVOKED AT ANY TIME BEFORE IT IS EXERCISED. A PROXY MAY BE REVOKED BY FILING WITH THE SECRETARY OF THE COMPANY A WRITTEN REVOCATION OR A DULY EXECUTED PROXY BEARING A LATER DATE. ANY STOCKHOLDER PRESENT AT THE MEETING MAY REVOKE HIS OR HER PROXY AND VOTE PERSONALLY ON EACH MATTER BROUGHT BEFORE THE MEETING. HOWEVER, IF YOU ARE A STOCKHOLDER WHOSE SHARES ARE NOT REGISTERED IN YOUR OWN NAME, YOU WILL NEED ADDITIONAL DOCUMENTATION FROM YOUR RECORD HOLDER IN ORDER TO VOTE PERSONALLY AT THE MEETING. By Order of the Board of Directors Paul L. Teem, Jr. Corporate Secretary Gastonia, North Carolina August __, 2002 - -------------------------------------------------------------------------------- IMPORTANT: A SELF-ADDRESSED ENVELOPE IS ENCLOSED FOR YOUR CONVENIENCE. NO POSTAGE IS REQUIRED IF MAILED WITHIN THE UNITED STATES. - -------------------------------------------------------------------------------- QUESTIONS AND ANSWERS FOR STOCKHOLDERS OF CITIZENS SOUTH BANKING CORPORATION You should read this document and the accompanying prospectus (which includes a detailed index) for more information about the conversion and reorganization. The plan of conversion and reorganization described herein has been conditionally approved by our regulators. Q. WHAT ARE STOCKHOLDERS BEING ASKED TO APPROVE? A. Citizens South Banking Corporation stockholders as of August __, 2002 are asked to vote on the plan of conversion and reorganization. Pursuant to the plan, Citizens South Holdings, MHC will convert from the mutual holding company form to the fully public form of corporate structure (the "Conversion") and as part of the Conversion, we will offer for sale Citizens South Holdings, MHC's ownership interest in Citizens South Banking Corporation Q. WHAT ARE REASONS FOR THE MUTUAL-TO-STOCK CONVERSION AND RELATED OFFERING? A. The primary reasons for the conversion are to facilitate acquisitions of other financial institutions, support internal growth through lending, improve our overall competitive position and enhance shareholder returns. The additional capital raised in the conversion will also support increased lending, expansion of our retail banking franchise, and introduction of new products and services. Q. WHAT WILL STOCKHOLDERS RECEIVE FOR THEIR EXISTING CITIZENS SOUTH BANKING CORPORATION SHARES? A. As more fully described in the prospectus section entitled "The Conversion," depending on the number of shares sold in the offering, each share of common stock that you own upon completion of the Conversion will be exchanged for between _________ new shares at the minimum and _________ new shares at the maximum of the offering range (though cash will be paid in lieu of fractional shares). Q. WHY WILL THE SHARES THAT I RECEIVE BE BASED ON A PRICE OF $10.00 PER SHARE RATHER THAN THE TRADING PRICE OF THE COMMON STOCK PRIOR TO THE CONVERSION? A. The Board of Directors of Citizens South Banking Corporation selected a price of $10.00 per share for the stock offered for sale because it is a commonly selected per share price for mutual-to-stock conversions. The number of new shares you receive for your existing Citizens South Banking Corporation shares does not depend on the market price of Citizens South Banking Corporation common stock. It will depend on the number of shares sold in the offering, which will in turn depend on the final independent appraisal of the pro forma market value of Citizens South Banking Corporation, assuming completion of the Conversion and offering. The result will be that each existing stockholder will own the same percentage of Citizens South Banking Corporation after the Conversion as was held just prior thereto, exclusive of (i) any shares purchased by the stockholder in the offering and (ii) cash received in lieu of fractional shares. Q. SHOULD I SUBMIT MY STOCK CERTIFICATES NOW? A. No. If you hold your certificate(s), instructions for exchanging the shares will be sent to you after completion of the Conversion. If your shares are held in "street name," rather than in certificate form, the share exchange will occur automatically upon completion of the Conversion. Q. WILL MY DIVIDENDS DECREASE? A. No. Citizens South Banking Corporation currently pays a quarterly dividend of $_________ per share (or $_________ per share annualized). The number of new stock shares that will be issued to you will be different from the number that you currently own. However, the per share dividend for these new shares will be adjusted (i) to ensure that your aggregate dividends do not decrease. For example, if _________ new shares are issued for each Citizens South Banking Corporation share owned at the conclusion of the Conversion, the quarterly dividend per share will be $_________. Of course, there is no assurance that the Board of Directors will not change the dividend policy in the future or eliminate dividends. Q. IF MY SHARES ARE HELD IN STREET NAME, WILL MY BROKER AUTOMATICALLY VOTE ON MY BEHALF? A. No. Your broker will not be able to vote your shares without instructions from you. You should instruct your broker to vote your shares, using the directions that your broker provides to you. Q. WHAT IF I DO NOT GIVE VOTING INSTRUCTIONS TO MY BROKER? A. Your vote is important. If you do not instruct your broker to vote your shares, the unvoted proxy will have the same effect as a vote against the plan of conversion. Q. MAY I PLACE AN ORDER TO PURCHASE SHARES IN THE OFFERING, IN ADDITION TO THE SHARES THAT I WILL RECEIVE IN THE EXCHANGE? A. Yes. Eligible Citizens South Bank depositors have priority subscription rights allowing them to purchase common stock in the subscription offering. Shares not purchased in the subscription offering may be available for sale to the public in a community offering, as fully described in the prospectus. Citizens South Banking Corporation stockholders as of August __, 2002 have a preference in the community offering. If you hold your stock certificate(s), you were mailed a stock order form and order reply envelope with this document. If you hold your shares in street name with a broker, you must call the stock information center if you would like to receive a stock order form. The toll free telephone number is (___) ___-____. Other Questions? For answers to other questions, please read the Proxy Statement and the prospectus, which includes a Questions and Answers section. Questions about the offering or voting may be directed to the information center by calling, toll free, (___) ___-____, Monday through Friday, from 9:00 a.m. and 5:00 p.m., North Carolina Time. (ii) PROXY STATEMENT of CITIZENS SOUTH BANKING CORPORATION 245 West Main Avenue Gastonia, North Carolina 28053 (704) 868-5200 SPECIAL MEETING OF STOCKHOLDERS September __, 2002 This Proxy Statement is furnished in connection with the solicitation of proxies on behalf of the Board of Directors of Citizens South Banking Corporation (the "Company"), to be used at the Special Meeting of Stockholders of the Company (the "Meeting"), which will be held at The City Club of Gastonia, 532 South New Hope Road, Gastonia, North Carolina, on September __, 2002 at __:__ _.m., North Carolina Time, and all adjournments thereof. The accompanying Notice of Special Meeting of Stockholders and this Proxy Statement are first being mailed to stockholders on or about August __, 2002. - -------------------------------------------------------------------------------- REVOCATION OF PROXIES - -------------------------------------------------------------------------------- Stockholders who execute proxies in the form solicited hereby retain the right to revoke them in the manner described below. Unless so revoked, the shares represented by such proxies will be voted at the Meeting and all adjournments thereof. Proxies solicited on behalf of the Board of Directors of the Company will be voted in accordance with the directions given thereon. Please sign and return your Proxy in order for your vote to be counted. Where no instructions are indicated, proxies, if signed, will be voted "FOR" the proposal set forth in this Proxy Statement for consideration at the Meeting. Proxies may be revoked by sending written notice of revocation to the Secretary of the Company, at the address shown above, or by filing a duly executed proxy bearing a later date. The presence at the Meeting of any stockholder who had given a proxy shall not revoke such proxy unless the stockholder delivers his or her ballot in person at the Meeting or delivers a written revocation to the Secretary of the Company prior to the voting of such proxy. - -------------------------------------------------------------------------------- VOTING SECURITIES AND PRINCIPAL HOLDERS THEREOF - -------------------------------------------------------------------------------- Holders of record of the Company's common stock at the close of business on August __, 2002 (the "Voting Record Date") are entitled to one vote for each share held. As of the Voting Record Date, there were __________ shares of common stock issued and outstanding, __________ of which were held by Citizens South Holdings, MHC (the "Mutual Holding Company"), and __________ of which were held by stockholders other than the Mutual Holding Company ("Public Stockholders"). The presence in person or by proxy of at least a majority of the issued and outstanding shares of common stock entitled to vote is necessary to constitute a quorum at the Meeting. Pursuant to Office of Thrift Supervision ("OTS") regulations and the plan of conversion and reorganization (the "Plan"), completion of the conversion of Citizens South Holdings, MHC from the mutual to the stock form of organization (the "Conversion") is subject to the approval of the Plan by the OTS and by a majority of the total votes eligible to be cast by members of the Mutual Holding Company (i.e., depositors of Citizens South Bank (the "Bank")). In addition, the transactions incident to the Conversion and the Plan must be approved by at least two-thirds of the outstanding shares of common stock, and a majority of votes cast by Public Stockholders. With respect to the required affirmative vote of at least two-thirds of the outstanding shares of common stock, abstentions and broker non-votes will have the effect of a vote against the Plan. With respect to the required affirmative vote by a majority of votes cast by 1 stockholders other than the Mutual Holding Company, broker non-votes will be considered as shares not voted. Management believes that the Mutual Holding Company will vote all of its shares to approve the Plan. - -------------------------------------------------------------------------------- PROPOSAL I--APPROVAL OF THE PLAN OF CONVERSION AND REORGANIZATION - -------------------------------------------------------------------------------- In addition to this Proxy Statement, you have received as part of this mailing a Prospectus that describes the Company and the Conversion and related offering. The Prospectus is incorporated by reference into this Proxy Statement. Therefore, you should carefully read the Prospectus prior to voting on the proposal to be presented at the Meeting. Details of the Conversion are addressed in the Prospectus sections entitled "Summary" and "The Conversion." DISSENTERS' AND APPRAISAL RIGHTS Under OTS regulations, Public Stockholders will not have dissenters' rights or appraisal rights in connection with the exchange of their common stock for shares of common stock of Citizens South Banking Corporation pursuant to the exchange ratio described in the Prospectus. OTHER MATTERS The Board of Directors is not aware of any business to come before the Meeting other than the matters described above in this Proxy Statement. However, if any matters should properly come before the Meeting, it is intended that holders of the proxies will act as directed by a majority of the Board of Directors, except for matters related to the conduct of the Meeting, as to which they shall act in accordance with their best judgment. The Plan sets forth the terms, conditions, and provisions of the proposed Conversion. The Certificate of Incorporation and Bylaws of the new Delaware corporation are exhibits to the Plan. If you would like to receive an additional copy of the Prospectus, or a copy of the Plan and the Certificate of Incorporation and Bylaws of the Company, you must request such materials in writing, addressed to the Secretary of the new Delaware corporation at the address given above. Such requests must be received by the Company no later than September __, 2002. If the Company does not receive your request by such date, you will not be entitled to have such materials mailed to you. To the extent necessary to permit approval of the Plan, proxies may be solicited by officers, directors, or regular employees of the Company and/or the Bank, in person, by telephone, or through other forms of communication and, if necessary, the Meeting may be adjourned to a later date. Such persons will be reimbursed by the Company and/or the Bank for their reasonable out-of-pocket expenses, including, but not limited to, telephone and postage expenses incurred in connection with such solicitation. The Company and/or the Bank have not retained a proxy solicitation firm to provide advisory services in connection with the solicitation of proxies. The cost of solicitation of proxies will be borne by the Company. The Company will reimburse brokerage firms and other custodians, nominees, and fiduciaries for reasonable expenses incurred by them in sending proxy materials to the beneficial owners of common stock. YOUR VOTE IS IMPORTANT! THE BOARD OF DIRECTORS RECOMMENDS THAT YOU VOTE FOR THE PLAN. THIS PROXY STATEMENT IS NOT AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SHARES IN THE OFFERING. THE OFFER IS MADE ONLY BY THE PROSPECTUS. BY THE ORDER OF THE BOARD OF DIRECTORS Paul L. Teem, Jr. Corporate Secretary Gastonia, North Carolina August __, 2002 2 REVOCABLE PROXY CITIZENS SOUTH BANKING CORPORATION SPECIAL MEETING OF STOCKHOLDERS September __, 2002 The undersigned hereby appoints the full Board of Directors, with full powers of substitution to act as attorneys and proxies for the undersigned to vote all shares of Common Stock of Citizens South Banking Corporation (the "Company") which the undersigned is entitled to vote at a Special Meeting of Stockholders ("Meeting") to be held at the City Club of Gastonia, Gastonia, North Carolina, at __:__ _.m., North Carolina Time, on September __, 2002. The official proxy committee is authorized to cast all votes to which the undersigned is entitled as follows: FOR AGAINST --- ------- 1. A plan of conversion and reorganization (the "Plan") pursuant to which the Mutual Holding Company will be merged into the Bank, and the Company will be succeeded by a new Delaware corporation with the same name as the Company which has been established for the purpose of completing the conversion and reorganization. As part of the conversion, shares of common stock representing the Mutual Holding Company's ownership interest in the Company will be offered for sale in a subscription and community offering. Common stock of the Company currently held by public stockholders will be converted into new shares pursuant to an exchange ratio that will ensure that stockholders at the time of the conversion will own the same percentage of Citizens South Banking Corporation after the conversion as was held immediately prior thereto, exclusive of any shares purchased by the stockholder in the offering and cash received in lieu of fractional shares. The Board of Directors recommends a vote "FOR" the listed proposal. - -------------------------------------------------------------------------------- IF SIGNED, THIS PROXY WILL BE VOTED AS DIRECTED, BUT IF NO INSTRUCTIONS ARE SPECIFIED, THIS PROXY, IF SIGNED, WILL BE VOTED FOR THE PROPOSITION STATED ABOVE. IF ANY OTHER BUSINESS IS PRESENTED AT SUCH MEETING, THIS PROXY WILL BE VOTED BY THE ABOVE-NAMED PROXIES AT THE DIRECTION OF A MAJORITY OF THE BOARD OF DIRECTORS. AT THE PRESENT TIME, THE BOARD OF DIRECTORS KNOWS OF NO OTHER BUSINESS TO BE PRESENTED AT THE MEETING. - -------------------------------------------------------------------------------- THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS Should the undersigned be present and elect to vote at the Meeting or at any adjournment thereof and after notification to the Secretary of the Company at the Meeting of the stockholder's decision to terminate this proxy, then the power of said attorneys and proxies shall be deemed terminated and of no further force and effect. This proxy may also be revoked by sending written notice to the Secretary of the Company at the address set forth on the Notice of Special Meeting of Stockholders, or by the filing of a later-dated proxy prior to a vote being taken on a particular proposal at the Meeting. Dated: _________________, 2002 - --------------------------- ---------------------------- PRINT NAME OF STOCKHOLDER PRINT NAME OF STOCKHOLDER - --------------------------- ---------------------------- SIGNATURE OF STOCKHOLDER SIGNATURE OF STOCKHOLDER Please sign exactly as your name appears on this card. When signing as attorney, executor, administrator, trustee, or guardian, please give your full title. If shares are held jointly, each holder should sign. - -------------------------------------------------------------------------------- Please complete, date and sign this proxy and return it promptly in the enclosed postage-paid envelope. - -------------------------------------------------------------------------------- -----END PRIVACY-ENHANCED MESSAGE-----