-----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, GxmSlt8ZWkcrC4HWeSJgonVeQYeZCqedKuBgv0Nu6c0UwBaouN+q21FNcKwxb5hG cq5DR/Q/YMp6TFzOCb7G0g== 0000950169-98-000101.txt : 19980212 0000950169-98-000101.hdr.sgml : 19980212 ACCESSION NUMBER: 0000950169-98-000101 CONFORMED SUBMISSION TYPE: SB-2/A PUBLIC DOCUMENT COUNT: 5 FILED AS OF DATE: 19980211 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: GASTON FEDERAL BANCORP INC CENTRAL INDEX KEY: 0001051871 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] FILING VALUES: FORM TYPE: SB-2/A SEC ACT: SEC FILE NUMBER: 333-42951 FILM NUMBER: 98531050 BUSINESS ADDRESS: STREET 1: 245 WEST MAIN STREET CITY: GASTONIA STATE: NC ZIP: 28053 MAIL ADDRESS: STREET 1: 245 WEST MAIN STREET CITY: GASTONIA STATE: NC ZIP: 28053 SB-2/A 1 GASTON FEDERAL BANCORP, INC. AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 11, 1998 REGISTRATION NO. 333-42951 - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 PRE-EFFECTIVE AMENDMENT NO. 2 TO FORM SB-2 REGISTRATION STATEMENT AND EXHIBITS UNDER THE SECURITIES ACT OF 1933 GASTON FEDERAL BANCORP, INC. (Exact name of registrant as specified in its charter)
FEDERAL 6712 (TO BE APPLIED FOR) (State or other jurisdiction of (Primary standard (I.R.S. Employer incorporation or organization) industrial classification) identification number)
245 WEST MAIN AVENUE, P.O. BOX 2249 GASTONIA, NORTH CAROLINA 28053-2249 (704) 868-5200 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) KIM S. PRICE PRESIDENT AND CHIEF EXECUTIVE OFFICER GASTON FEDERAL BANCORP, INC. 245 WEST MAIN AVENUE, P.O. BOX 2249 GASTONIA, NORTH CAROLINA 28053-2249 (704) 868-5200 (Name, address, including zip code, and telephone number, including area code, of agent for service) Copies to: JOHN J. GORMAN, ESQ. KENNETH R. LEHMAN, ESQ. LUSE LEHMAN GORMAN POMERENK & SCHICK 5335 WISCONSIN AVENUE, N.W. SUITE 400 WASHINGTON, D.C. 20015 Approximate date of commencement 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 securities for an offering pursuant to Rule 462(b) 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 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 this form is a post-effective amendment filed pursuant to Rule 462(d) 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 delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box. [ ] CALCULATION OF REGISTRATION FEE
PROPOSED PROPOSED MAXIMUM TITLE OF EACH CLASS OF AMOUNT TO BE MAXIMUM OFFERING AGGREGATE AMOUNT OF SECURITIES TO BE REGISTERED REGISTERED PRICE PER SHARE OFFERING PRICE (1) REGISTRATION FEE Common Stock, $1.00 par value per share 2,113,355 shares $10.00 $21,133,550 $6,234.40 (2) Participation Interests(3) 185,000 shares - - -
- ------------------------------------ (1) Estimated solely for the purpose of calculating the registration fee. (2) $5,977 previously paid. (3) The securities of Gaston Federal Bancorp, Inc. to be purchased by the Gaston Federal Bancorp, Inc. and Gaston Federal Savings and Loan Association Employees' Savings and Profit Sharing Plan are included in the amount shown for Common Stock. Accordingly, 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 UP TO 2,113,355 SHARES OF COMMON STOCK GASTON FEDERAL BANCORP, INC. 245 WEST MAIN AVENUE GASTONIA, NORTH CAROLINA 28053-2249 (704) 868-5200 ================================================================================ Gaston Federal Savings and Loan Association, a mutual savings association, is reorganizing into the mutual holding company structure. As part of the reorganization, Gaston Federal Savings and Loan Association will change its name to Gaston Federal Bank and will become a wholly-owned subsidiary of Gaston Federal Bancorp, Inc., a federal corporation. Gaston Federal Bancorp, Inc. will issue a majority of its common stock to Gaston Federal Holdings, MHC, a federal mutual holding company, and sell a minority of its common stock to the public. The shares of common stock of Gaston Federal Bancorp, Inc. are being offered to the public under the terms of a plan of reorganization that must be approved by members of Gaston Federal Savings and Loan Association and by the Office of Thrift Supervision. The reorganization will not go forward if Gaston Federal Savings and Loan Association does not receive these approvals, or if Gaston Federal Bancorp, Inc. does not sell at least a minimum number of shares of its common stock. Because the names of Gaston Federal Savings and Loan Association, Gaston Federal Bank, Gaston Federal Bancorp, Inc. and Gaston Federal Holdings, MHC are so similar, we will refer to Gaston Federal Savings and Loan Association and Gaston Federal Bank as the "Bank," we will refer to Gaston Federal Bancorp, Inc. as the "Stock Company," and we will refer to Gaston Federal Holdings, MHC as the "Mutual Company." ================================================================================ TERMS OF OFFERING An independent appraiser has estimated that the market value of Stock Company after giving effect to the reorganization is between $28,900,000 to $39,100,000. Based on the valuation, the Stock Company will issue between 2,890,000 and 3,910,000 shares of its common stock in the reorganization. The Stock Company intends to sell 47% of these shares, or between 1,358,300 and 1,837,700 shares, to the public, and issue 53% of these shares, or between 1,531,700 and 2,072,300 shares, to the Mutual Company. We may increase the shares we issue in the reorganization to up to 4,496,500 shares. If we increase the shares we issue in the reorganization we will also increase the shares we sell in the offering to up to 2,113,355 shares. The number of shares we will issue is subject to OTS approval. Based on these estimates, we are making the following offering of shares of common stock.
Adjusted Minimum Midpoint Maximum Maximum ------- -------- ------- ------- o Price per share $10.00 $10.00 $10.00 $10.00 o Number of shares 1,358,300 1,598,000 1,837,700 2,113,355 o Reorganization expenses $722,000 $770,000 $818,000 $873,000 o Net Proceeds $12,861,000 $15,210,000 $17,559,000 $20,261,000 o Net Proceeds per share $9.47 $9.52 $9.55 $9.59
PLEASE REFER TO RISK FACTORS BEGINNING ON PAGE _____ OF THIS DOCUMENT. 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, THE FEDERAL DEPOSIT INSURANCE CORPORATION, NOR ANY STATE SECURITIES REGULATOR HAS APPROVED OR DISAPPROVED THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS ACCURATE OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. Trident Securities, Inc. will use its best efforts to assist in selling at least the minimum number of shares but does not guarantee that this number will be sold. All funds received from subscribers will be held in an interest bearing savings account at the Bank until the completion or termination of the offering. The Stock Company has received preliminary approval to have the common stock quoted on the Nasdaq Stock Market under the symbol "GBNK." For information on how to subscribe, call the Stock Information Center at (704) 868-8155. TRIDENT SECURITIES, INC. Prospectus dated February 12, 1998 TABLE OF CONTENTS PAGE ---- QUESTIONS AND ANSWERS ABOUT THE STOCK OFFERING................................1 SUMMARY .....................................................................4 SELECTED FINANCIAL AND OTHER DATA.............................................8 RISK FACTORS..................................................................9 GASTON FEDERAL HOLDINGS, MHC.................................................13 GASTON FEDERAL BANCORP, INC..................................................14 GASTON FEDERAL SAVINGS AND LOAN ASSOCIATION..................................14 REGULATORY CAPITAL COMPLIANCE................................................15 USE OF PROCEEDS..............................................................15 DIVIDEND POLICY..............................................................16 MARKET FOR COMMON STOCK......................................................17 CAPITALIZATION...............................................................18 PRO FORMA DATA...............................................................19 PARTICIPATION BY MANAGEMENT..................................................22 GASTON FEDERAL SAVINGS AND LOAN ASSOCIATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME...................................23 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...................24 BUSINESS OF THE COMPANY......................................................31 BUSINESS OF THE BANK.........................................................31 FEDERAL AND STATE TAXATION...................................................50 REGULATION...................................................................51 MANAGEMENT OF THE COMPANY....................................................58 MANAGEMENT OF THE BANK ......................................................59 THE REORGANIZATION AND OFFERING..............................................66 RESTRICTIONS ON ACQUISITION OF THE COMPANY...................................79 DESCRIPTION OF CAPITAL STOCK OF THE COMPANY..................................81 TRANSFER AGENT AND REGISTRAR.................................................82 LEGAL AND TAX MATTERS........................................................82 EXPERTS ....................................................................82 ADDITIONAL INFORMATION.......................................................82 This document contains forward-looking statements which involve risks and uncertainties. The Stock Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in "Risk Factors" section of this Prospectus. Please see the Glossary beginning on page G-l for the meaning of capitalized terms that are used in this Prospectus. 2 QUESTIONS AND ANSWERS ABOUT THE STOCK OFFERING Q: WHAT IS THE PURPOSE OF THE OFFERING? A: We are selling shares of common stock so that we can raise capital and compete and expand more effectively and so that our depositors, employees, management and directors may obtain an equity ownership in the Bank. As part of the reorganization, you will have the opportunity to become a shareholder of the Stock Company, which will allow you to share indirectly in the future of our Bank. The offering will increase our capital for lending and investment activities. This will better enable us to continue the expansion of our retail banking franchise and to diversify operations. Further, as a stock bank operating through a holding company structure, we will improve our future access to the capital markets. Q: HOW DO I ORDER THE STOCK? A: You must complete and return the stock order form and certification to us together with your payment, so that we receive it on or before 12:00 noon on March 17, 1998. Q: HOW MUCH STOCK MAY I ORDER? A: The minimum order is 25 shares (or $250). The maximum order for any individual person, persons on a single account, or persons acting together is 25,000 shares (or $250,000). We may decrease or increase the maximum purchase limitation without notifying you. However, if we increase the maximum purchase limitation, and you previously subscribed for the maximum number of shares, you will be given the opportunity to subscribe for additional shares. Q: WHAT HAPPENS IF THERE ARE NOT ENOUGH SHARES TO FILL ALL ORDERS? A: If the offering is oversubscribed, we will allocate shares based on the purchase priorities that we have adopted in the plan of reorganization and stock issuance plan. These purchase priorities are in accordance with regulations of the Office of Thrift Supervision. If the offering is oversubscribed in a particular category, then shares will be allocated among all subscribers in that category based on a formula that is described in detail in "The Reorganization and Offering." The priorities are described in answer to the next question. Q: WHO WILL BE PERMITTED TO PURCHASE STOCK? A: The stock will be offered on a priority basis to the following persons: o Persons who had deposit accounts of at least $50 with us on March 31, 1996. Any remaining shares will be offered to: o The Stock Company's employee stock ownership plan. Any remaining shares will be offered to: o Persons who had deposit accounts of at least $50 with us on December 31, 1997. Any remaining shares will be offered to: o Persons who had deposit accounts of at least $50 with us on February 6, 1998. If the above persons do not subscribe for all of the shares, the remaining shares will be offered to certain members of the general public, with preference given to natural persons residing in Gaston County, North Carolina. 3 Q: AS A DEPOSITOR OF THE BANK, WHAT WILL HAPPEN IF I DO NOT ORDER ANY STOCK? A: You are not required to purchase common stock. Your deposit accounts, certificate accounts and any loans you may have with us will not be affected by the reorganization. Q: HOW DO I DECIDE WHETHER TO BUY STOCK IN THE OFFERING? A: In order to make an informed investment decision, you should read this entire Prospectus, particularly the section titled "Risk Factors." Q: WHO CAN HELP ANSWER ANY QUESTIONS I MAY HAVE ABOUT THE OFFERING? If you have questions about the offering, you may contact: STOCK INFORMATION CENTER GASTON FEDERAL SAVINGS AND LOAN ASSOCIATION 245 WEST MAIN AVENUE P.O. BOX 2249 GASTONIA, NORTH CAROLINA 28053-2249 (704) 868-8155 4 SUMMARY AND OVERVIEW Generally. This summary highlights selected information from this document and does not contain all the information that you need to know before making an informed investment decision. To understand the offering fully, you should read carefully this entire Prospectus, including the consolidated financial statements and the notes to the consolidated financial statements of the Bank. References in this document to the "Bank," "we," "us," or "our" refer to Gaston Federal Savings and Loan Association and/or Gaston Federal Bank. In certain instances where appropriate, "us" or "our" refers collectively to Gaston Federal Bancorp, Inc. and the Bank. References in this document to the "Stock Company" refer to Gaston Federal Bancorp, Inc. References to the "Mutual Company" refer to Gaston Federal Holdings, MHC. THE REORGANIZATION AND OFFERING The reorganization involves a number of steps, including the following: o The Bank will establish the Stock Company and the Mutual Company, neither of which will have any assets prior to the completion of the reorganization. o The Bank will convert from the mutual form of organization to the capital stock form of organization and issue 100% of its capital stock to the Stock Company. o The Stock Company will issue between 2,890,000 and 4,496,500 shares of its common stock in the reorganization; 53% of these shares (or between 1,531,700 shares and 2,383,145 shares) will be issued to the Mutual Company, and 47% (or between 1,358,300 shares and 2,113,355 shares) will be sold to depositors, and possibly the public. o Membership interests that depositors had in the Bank will become membership interests in the Mutual Company. As a result, former members of the Bank who controlled 100% of the votes eligible to be cast by the Bank's members prior to the reorganization will, through the Mutual Company, control 53% of the votes eligible to be cast by the Bank's stockholders immediately following the reorganization. DESCRIPTION OF THE MUTUAL COMPANY STRUCTURE The mutual holding company structure differs in significant respects from the savings and loan holding company structure that is used in a standard mutual to stock conversion. In a standard conversion, a converting mutual institution or its newly-formed holding company usually sells 100% of its common stock in a stock offering. A savings institution that converts from the mutual to stock form of organization using the mutual holding company structure sells less than half of its shares at the time of the reorganization. By doing so, a converting institution using the mutual holding company structure will raise less than half the proceeds that it would raise in a standard mutual to stock conversion. Because less than half the proceeds are raised, the Stock Company and the Bank will not have their performance impeded by having too much capital to deploy. The shares that are issued to the mutual holding company may be subsequently sold to the Bank's depositors if the mutual holding company converts from the mutual to the stock form of organization. See "Conversion of the Mutual Company to the Stock Form of Organization." In addition, because the Mutual Company controls a majority of the Stock Company's common stock, we believe that the reorganization and offering will permit the Bank to achieve the benefits of a stock company without a loss of control that often follows a standard conversion from 5 mutual to stock form. Sales of locally based, independent savings institutions to larger, regional financial institutions can result in closed branches, fewer choices for consumers, employee layoffs and the loss of community support for and involvement by financial institutions. Because the Mutual Company is a mutual corporation, its actions will not necessarily always be in the interests of the Bank's stockholders. In making business decisions, the Mutual Company's Board of Directors, will consider a variety of constituencies, including the depositors of the Bank, the employees of the Bank, and the communities in which the Bank operates. As the majority stockholder of the Stock Company, the Mutual Company is also interested in the continued success and profitability of the Bank and the Stock Company. Consequently, the Mutual Company will act in a manner which furthers the general interest of all of its constituencies, including, but not limited to, the interest of the stockholders of the Stock Company. The Mutual Company believes that the interests of the stockholders of the Stock Company, and those of the Mutual Company's other constituencies, are in many circumstances the same, such as the increased profitability of the Stock Company and the Bank and continued service to the communities in which the Bank operates. CONVERSION OF THE MUTUAL COMPANY TO THE STOCK FORM OF ORGANIZATION Office of Thrift Supervision regulations and the plan of reorganization permit the Mutual Company to convert from the mutual to the capital stock form of organization. If the Mutual Company were to convert to the capital stock form of organization the transaction would probably be structured as follows: o The Mutual Company and the Stock Company would cease to exist. o The Bank would form a new stock holding company. o The new stock holding company would sell shares of its common stock in a subscription offering to certain depositors. o In addition to the shares it would sell in the subscription offering, the new stock holding company would issue shares of its common stock to the Stock Company's stockholders in exchange for their shares of the Stock Company's common stock. After the conversion, the Stock Company's stockholders would own approximately the same percentage of the new stock holding company as they owned of the Stock Company. Purchasers in the subscription offering would own approximately the same percentage of the new stock holding company as the Mutual Company owned in the Stock Company prior to the conversion. If the Mutual Company waived any dividends paid by the Stock Company prior to the conversion, however, then the Stock Company's stockholders would receive a smaller percentage of the new stock holding company's common stock. There can be no assurance that the Mutual Company will convert to the stock form, and the Board of Directors has no current intention or plan to do so. THE COMPANIES Gaston Federal Bancorp, Inc. 245 West Main Avenue P.O. Box 2249 Gastonia, North Carolina 28053-2249 (704) 868-5200 After the reorganization the Stock Company will own all of the Bank's common stock. Purchasers in the offering will own 47% of the Stock Company's common stock and the Mutual Company will own 53% of the Stock Company's common stock. Although these percentages may change in the future, the Mutual Company must always 6 own a majority of the Stock Company's common stock. The holding company structure will provide us greater flexibility in terms of operations, expansion and diversification. See page ____. Gaston Federal Bank 245 West Main Avenue P.O. Box 2249 Gastonia, North Carolina 28053-2249 (704) 868-5200 We are a community- and customer-oriented federal mutual savings association. We provide financial services to individuals, families and small businesses primarily in Gaston County and its four contiguous counties in North and South Carolina. We are engaged primarily in the business of attracting retail deposits through our four branch offices and investing those deposits, together with funds generated from operations and borrowings, in one-to four-family residential, multi-family residential and commercial real estate loans, construction loans, commercial business loans, consumer loans, and investment and mortgage-backed securities. At September 30, 1997, we had total assets of $173.5 million, total deposits of $145.4 million and total equity of $20.9 million. See pages _____ to_____. THE STOCK OFFERING The Stock Company is offering for sale between 1,350,300 and 1,837,700 shares of its common stock, for a price per share of $10.00. If market or financial conditions change, we may increase the offering to up to 2,113,355 shares without further notice to you. The number of shares that we sell in the offering is subject to OTS approval. STOCK PURCHASE PRIORITIES The Stock Company will offer shares of its common stock on the basis of purchase priorities. Certain depositors and the Bank's employee stock ownership plan will receive subscription rights to purchase shares. We may offer shares not purchased in this subscription offering to the general public in a community offering. We have engaged Trident Securities, Inc. to assist us on a best efforts basis in selling the common stock in the offering. See pages _____ to _____. PROHIBITION ON TRANSFER OF SUBSCRIPTION RIGHTS You may not sell or assign your subscription rights. Any transfer of subscription rights is prohibited by law. STOCK PRICING AND NUMBER OF SHARES TO BE ISSUED The Bank's board of directors set the subscription price per share at $10.00, the subscription price most commonly used in stock offerings involving mutual to stock conversions of mutual savings institutions. The number of shares of common stock issued in the offering is based on the independent valuation prepared by Feldman Financial Advisors, Inc., Washington, D.C. The independent valuation states that as of December 11, 1997, the estimated market value of the Stock Company after giving effect to the reorganization ranged from a minimum of $28,900,000 to a maximum of $39,100,000. Based on the independent valuation and the subscription price, the number of shares of common stock that the Stock Company will issue will range from between 2,890,000 shares to 3,910,000 shares. The Bank has decided to offer 47% of these shares, or between 1,350,300 shares and 1,837,700 shares, to depositors and the public pursuant to this Prospectus. The Board of Directors determined to sell 47% of the stock in the offering in order to raise the maximum amount of proceeds while permitting the Stock Company to issue additional shares of common stock in the future pursuant to the restricted stock plan and stock option plan that the Stock Company intends to adopt at least six months after the reorganization and offering. The 53% of the shares of Company's common stock that are not sold in the offering will be issued to the Mutual Company. 7 Changes in the market and financial conditions and demand for the common stock may result in an increase of up to 15% in the independent valuation (to up to $44,965,000) and a corresponding increase in the maximum of the offering range (to up to 2,113,355 shares). The number of shares that we issue is subject to OTS approval. We will not notify subscribers if the maximum of the independent valuation and the maximum of the offering range are increased by 15% or less. We will, however, notify subscribers if the maximum of the independent valuation is increased by more than 15% or if the minimum of the independent valuation is decreased. THE INDEPENDENT VALUATION IS NOT A RECOMMENDATION OF AS TO THE ADVISABILITY OF PURCHASING SHARES, AND YOU SHOULD NOT BUY STOCK BASED ON THE INDEPENDENT VALUATION. TERMINATION OF THE OFFERING The subscription offering will terminate at 12:00 noon, local time, on March __, 1998. If a community offering is held, it is expected to begin immediately after the termination of the subscription offering, but may begin during the subscription offering. The Stock Company may terminate any community offering at any time prior to April ___, 1998, or later if permitted by the OTS. BENEFITS TO MANAGEMENT FROM THE OFFERING Our full-time employees will participate in our employee stock ownership plan. We also intend to implement a restricted stock plan and a stock option plan following completion of the reorganization, which will benefit our officers and directors. If we adopt the restricted stock plan, certain officers and directors will be awarded shares of common stock at no cost to them. However, the restricted stock plan and stock option plan may not be adopted until at least six months after completion of the reorganization and are subject to shareholder approval. See pages _____ to _____. USE OF THE PROCEEDS RAISED FROM THE SALE OF COMMON STOCK The Stock Company will use the net proceeds from the offering as follows. The percentages we use are estimates: o 50% will be used to buy all the capital stock of the Bank. o 8% will be loaned to the ESOP to fund its purchase of common stock. o 42% will be retained as a possible source of funds for the payment of dividends to shareholders, the repurchase of stock, and for other general corporate purposes. The proceeds to be received by the Bank will be available for continued expansion of the retail banking franchise through new branch openings or deposit or branch acquisitions, continued growth in the loan portfolio, and the purchase of investment and mortgage-backed securities, in addition to general corporate purposes. See pages _____ to _____. DIVIDENDS The Stock Company intends to pay an annual cash dividend of $.20 payable quarterly at $.05 per share. The payment of dividends is expected to begin following the first full quarter after completion of the reorganization. MARKET FOR THE COMMON STOCK We have received conditional approval to have the Stock Company's common stock quoted on the Nasdaq National Market System under the symbol "GBNK." The conditions to this approval include a minimum market value of the Company's common stock, and a minimum number of market makers and record holders. Trident 8 Securities, Inc. has indicated its intention to make a market in the common stock, and based on our analysis of the results of recent conversion stock offerings we anticipate that the Stock Company will satisfy the conditions imposed by Nasdaq. If we are unable, for any reason, to list the common stock on the Nasdaq National Market, or to continue to be eligible for listing, then we intend to list the common stock on the Nasdaq SmallCap Market under the same symbol, or on the American Stock Exchange, if we qualify under their listing criteria . See page ______. 9 SELECTED FINANCIAL AND OTHER DATA We are providing the following summary financial information about us for your benefit. This information is derived from our audited financial statements for each of the fiscal years shown below. The following information is only a summary and you should read it in conjunction with our consolidated (including consolidated data from operations of our subsidiary) financial statements and notes beginning on page F-1. SELECTED FINANCIAL DATA
At September 30, -------------------------------- 1997 1996 ------------- --------------- (Dollars in Thousands) Total assets...................................................................... $ 173,470 $ 171,953 Loans receivable, net ............................................................ 134,491 130,862 Mortgage-backed securities........................................................ 10,087 12,918 United States government and agency securities held to maturity................... 10,407 14,751 United States government and agency securities available for sale................. 2,009 -- Other investments available for sale.............................................. 6,239 5,515 Deposits.......................................................................... 145,444 145,975 Borrowed funds.................................................................... 3,500 3,750 Total equity...................................................................... 20,868 19,084
SUMMARY OF OPERATIONS
Years Ended September 30, ------------------------------ 1997 1996 ------------- ------------- (Dollars in Thousands) Interest income................................................................... $ 12,936 $ 12,518 Interest expense.................................................................. 6,952 7,381 ---------- ---------- Net interest income............................................................... 5,984 5,137 Provision for loan losses......................................................... 293 47 ---------- ---------- Net interest income after provision for loan losses............................... 5,691 5,090 Non-interest income............................................................... 516 417 Non-interest expense (1).......................................................... 3,956 4,646(1) ---------- ---------- Income before income taxes........................................................ 2,251 861 Income tax expense................................................................ 819 351 ---------- ---------- Net income........................................................................ $ 1,432 $ 510 ========== ==========
- ---------- (1) Includes a non-recurring expense of $867 for the year ended September 31, 1996 for a one-time premium to recapitalize the Savings Association Insurance Fund. 10 KEY OPERATING RATIOS AND OTHER DATA
At and For the Years Ended September 30, ------------------------ 1997 1996 ------ ------ PERFORMANCE RATIOS: Return on average assets (net income divided by average total assets)............. 0.84% 0.30% Return on average equity (net income divided by average equity)................... 7.38 2.76 Net interest rate spread.......................................................... 3.24 2.82 Net interest margin............................................................... 3.50 3.03 Average interest-earning assets to average interest-bearing liabilities........... 109.92 108.29 Non interest expenses to total assets............................................. 2.28 2.70 Non-interest expenses to average total assets..................................... 2.31 2.74 ASSET QUALITY RATIOS: Nonperforming assets to total assets.............................................. 0.75 0.84 Nonperforming loans to total loans................................................ 0.76 0.88 Nonperforming loans to total assets............................................... 0.61 0.69 Allowance for loan losses to total loans at the end of period..................... 0.80 0.61 Allowance for loan losses to nonperforming loans.................................. 104.82 69.51 Net interest income after provision for loan losses, to total non-interest expenses 143.82 109.58 CAPITAL RATIOS: Ratio of average equity to average total assets................................... 11.34 10.92 Equity to assets at period end.................................................... 12.03 11.10 OTHER DATA: Number of real estate loans outstanding........................................... 1,999 2,060 Number of deposit accounts........................................................ 14,368 14,315 Number of full service offices.................................................... 4 4
11 RECENT DEVELOPMENTS The following tables set forth selected financial data for the Bank at December 31 and September 30, 1997 as well as a summary of operations and certain key operating ratios and other data for the three months ended December 31, 1997 and 1996. We prepared this information based on the unaudited consolidated financial statements of the Bank, which management believes to reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial information as of such dates and for such periods. The summary of operations and key operating ratios and other data for the three months ended December 31, 1997 and 1996 do not necessarily mean that results for any other period will be comparable. SELECTED FINANCIAL DATA
At At December 31, September 30, 1997 1997 ------------- -------------- (Dollars in Thousands) Total assets.................................................................... $ 173,437 $ 173,470 Loans receivable, net .......................................................... 134,530 134,491 Mortgage-backed securities...................................................... 9,547 10,087 United States government and agency securities held to maturity................. 9,660 10,407 United States government and agency securities available for sale............... 3,015 2,009 Other investments available for sale............................................ 5,607 6,239 Other investments held to maturity.............................................. 370 -- Deposits........................................................................ 146,306 145,444 Borrowed funds.................................................................. 3,500 3,500 Total equity.................................................................... 21,423 20,868
SUMMARY OF OPERATIONS
Three Months Ended December 31, ------------------------------ 1997 1996 ------------- ------------- (Dollars in Thousands) Interest income................................................................. $ 3,234 $ 3,181 Interest expense................................................................ 1,738 1,770 Net interest income............................................................. 1,496 1,411 Provision for loan losses....................................................... 75 59 Net interest income after provision for loan losses............................. 1,421 1,352 Non-interest income............................................................. 204 288 Non-interest expense ........................................................... 1,028 1,008 Net operating income before income taxes........................................ 597 632 Income tax expense.............................................................. 219 258 Net income...................................................................... 378 374
12 KEY OPERATING RATIOS AND OTHER DATA
At and For the Three Months Ended December 31, ------------------------- 1997 1996 ------ ------- PERFORMANCE RATIOS: Return on average assets (net income divided by average total assets)............. 0.87% 0.87% Return on average equity (net income divided by average equity)................... 7.18 7.74 Net interest rate spread.......................................................... 3.18 2.83 Net interest margin............................................................... 3.45 3.34 Average interest-earning assets to average interest-bearing liabilities........... 111.98 111.94 Non interest expenses to total assets............................................. 2.37 2.23 Non-interest expenses to average total assets..................................... 2.36 2.21 ASSET QUALITY RATIOS: Nonperforming assets to total assets.............................................. 0.79 0.78 Nonperforming loans to total loans................................................ 0.80 0.78 Nonperforming loans to total assets............................................... 0.65 0.63 Allowance for loan losses to total loans at the end of period..................... 0.84 0.62 Allowance for loan losses to nonperforming loans.................................. 105.25 78.93 Net interest income after provision for loan losses, to total non-interest expenses 138.23 134.13 ====== ====== CAPITAL RATIOS: Ratio of average equity to average total assets................................... 12.10 11.28 Equity to assets at period end.................................................... 12.35 11.49 OTHER DATA: Number of real estate loans outstanding........................................... 1,998 2,041 Number of deposit accounts........................................................ 14,369 14,414 Number of full service offices.................................................... 4 4
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1997, AND SEPTEMBER 30, 1997 Assets. Total assets decreased by $33,000, from $173.5 million as of September 30, 1997, to $173.4 million as of December 31, 1997. Cash and cash equivalents increased by $271,000, or 5.9%, from $4.6 million to $4.9 million. Investment and mortgage-backed securities decreased by $543,000, or 1.9%, from $28.7 million to $28.2 million due to maturities and principal repayments. Total loans increased by $39,000 to $134.5 million at December 31, 1997. Total liabilities decreased by $588,000, or 0.4%, from $152.6 million as of September 30, 1997 to $152.0 million as of December 31, 1997. Total deposits increased by $862,000, or 0.6%, from $145.4 million to $146.3 million due to continued marketing efforts to attract deposits as a source of funds. Borrowed money remained constant at $3.5 million. Other noninterest costing liabilities decreased by $1.4 million, or 38.8%, from $3.6 million to $2.2 million. The primary reason for this change was a $968,000 decrease in advances from borrowers for taxes and insurance (escrows) due to the payment of annual property taxes in December 1997. Total Equity. Total equity as of December 31, 1997, amounted to $21.4 million, as compared to $20.9 million as of September 30, 1997. This represents an increase of $555,000, or 2.7%. This increase was due to current period earnings of approximately $378,000 and an increase in unrealized gains on securities held as available for sale of $177,000. 13 COMPARISON OF OPERATING RESULTS FOR THE QUARTERS ENDED DECEMBER 31, 1997 AND 1996 Net Income. Net income increased by $4,000, or 1.1%, from $374,000 for the quarter ended December 31, 1996, to $378,000 for the quarter ended December 31, 1997. Net Interest Income. Net interest income increased by $85,000, or 6.0%, from $1.4 million to $1.5 million. Interest income increased $53,000, or 1.7%, to $3.2 million. This change was primarily attributable to an increased mix of higher yielding loans during the quarter ended December 31, 1997. Interest expense decreased by $32,000, or 1.8%, to $1.7 million. This decrease was primarily due to a lower cost of funds which was attributable to falling interest rates and an increased level of lower costing deposits during the quarter ended December 31, 1997. Provisions for Loan Losses. The provision for loan losses during the respective quarters increased by $16,000, or 27.1% from $59,000 to $75,000. The increase was primarily due to the growth in our portfolio of higher-yielding construction, commercial and multifamily residential real estate, and commercial business loans. Based on our own experience, and industry experience, we believe that these types of loans expose our operations to greater risk of loss than the one- to four-family residential real estate loans that we have traditionally emphasized. The Bank's allowance for loan losses increased from $839,000, or 0.62% of total loans as of December 31, 1996, to $1,182,000, or 0.84% of total loans as of December 31, 1997. Noninterest Income. Noninterest income decreased from $288,000 to $204,000. This represents a decrease of $84,000, or 29.2%. This decrease was due, in part, to a $102,000 gain on sale of real estate owned and a $51,000 gain on sale of stock, which occurred during the quarter ended December 31, 1996. Realized gains from sale of investments held as available for sale amounted to $80,000 during the quarter ended December 31, 1997. Noninterest Expenses. Noninterest expenses increased by $20,000, or 2.0%, from $1.0 million. This increase was primarily due to higher compensation expenses associated with an increased number of employees. Provision for Income Taxes. The provision for income taxes decreased by $39,000, or 15.1% from $258,000 to $219,000. This was primarily due to a reduction of income before income taxes and the effect of state tax exempt interest income. RISK FACTORS In addition to the other information in this Prospectus, you should consider carefully the following risk factors in evaluating an investment in the common stock. DECREASED RETURN ON AVERAGE EQUITY IMMEDIATELY AFTER REORGANIZATION At September 30, 1997, the Bank's equity as a percentage of assets was 12.03%, and for the fiscal year ended September 30, 1997 our return on average equity (net income divided by average equity) was 7.38%. Our equity as a percentage of assets will significantly increase as a result of the net proceeds that we receive in the Offering. On a pro forma basis as of September 30, 1997, the Stock Company's equity as a percentage of consolidated assets would be approximately 20.1% at the adjusted maximum of the Offering Range. We currently anticipate that it will take time to prudently deploy the capital that we will raise in the Offering. As a result, until we have leveraged the capital we receive in the Offering by increasing our interest-earning assets (and our interest-bearing liabilities) and thereby reduced our equity as a percentage of assets to industry averages, our return on average equity is expected to be below the industry average. There can be no assurances that we will be able to successfully leverage our capital, or that we will be successful in generating future returns on equity equal to our historical returns or industry averages. 14 POTENTIAL EFFECTS OF CHANGES IN INTEREST RATES AND THE CURRENT INTEREST RATE ENVIRONMENT Our results of operations and financial condition are significantly affected by changes in interest rates. Our results of operations are substantially dependent 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 as a general matter our interest-bearing liabilities reprice or mature more quickly than our interest-earning assets, an increase in interest rates generally would result in a decrease in our average interest rate spread and net interest income. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Management of Interest Rate Risk." Changes in interest rates also affect the value of our interest-earning assets, and in particular our investment securities portfolio. Generally, the value of investment securities fluctuates inversely with changes in interest rates. At September 30, 1997, our securities portfolio totaled $28.7 million, including $8.2 million of securities available for sale. Unrealized gains and losses on securities available for sale are reported on a quarterly basis as a separate component of equity. Decreases in the fair value of securities available for sale therefore could have an adverse affect on stockholders' equity. See "Business of the Bank--Investment Activities." We are also subject to reinvestment risk relating to interest rate movements. Changes in interest rates can affect the average life of loans and mortgage-backed securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-backed securities, as borrowers refinance to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk to the extent that we are not able to reinvest such prepayments at rates that are comparable to the rates on the maturing loans or securities. LENDING RISKS ASSOCIATED WITH COMMERCIAL AND MULTI-FAMILY REAL ESTATE, COMMERCIAL BUSINESS AND CONSUMER LENDING At September 30, 1997, our portfolio of commercial real estate loans totaled $7.3 million, or 5.3% of total loans, our portfolio of commercial business loans totaled $5.6 million, or 4.0% of total loans, our portfolio of multi-family loans totaled $6.5 million, or 4.7% of total loans, and our portfolio of consumer and other loans totaled $7.4 million, or 5.3% of total loans. Most industry experts believe that commercial real estate, commercial business, multi-family and consumer loans expose a lender to a greater risk of loss than one-to-four-family residential loans. See "Business of the Bank--Lending Activities" and "Business of the Bank--Lending Activities--Nonperforming Assets and Delinquencies." MINORITY PUBLIC OWNERSHIP AND CERTAIN ANTI-TAKEOVER PROVISIONS Voting Control of the Mutual Company. Under OTS regulations, the Plan of Reorganization, and our governing corporate instruments, a majority of the Stock Company's voting shares must be owned by the Mutual Company, and the Mutual Company will own 53.0% of the Common Stock outstanding at the completion of the Reorganization and Offering. The Mutual Company will be controlled by its executive officers and directors, who initially will consist of persons who are executive officers and directors of the Stock Company. Executive officers and directors of the Stock Company will own 6.9% of the Common Stock outstanding at the completion of the Reorganization and Offering (assuming shares are sold at the midpoint of the Offering Range and that executive officers and directors receive all the shares for which they are expected to subscribe), and, based on such assumptions, the Mutual Company and executive officers and directors as a group would own 59.9% of the Common Stock outstanding at the conclusion of the Reorganization and Offering. The Mutual Company will elect all members of the Board of Directors of the Stock Company, and, with certain exceptions, will control the outcome of matters presented to the stockholders of the Stock Company for resolution by vote. The situations in which the Mutual Company may not control the outcome of such vote include any stockholder vote to approve a restricted stock plan or stock option plan instituted within one year of the Reorganization and Offering (which would require the approval of a majority of the shares other than shares held by the Mutual Company), any stockholder vote relating to the 15 Mutual Company's conversion from the mutual to the stock form of organization (which would require the approval of a majority of shares other than shares held by the Mutual Company and two-thirds of shares including shares held by the Mutual Company), or any other stockholder vote in which the OTS may impose such a requirement. The Mutual Company, acting through its Board of Directors, will be able to control the business and operations of the Stock Company and the Bank and will be able to prevent any challenge to the ownership or control of the Stock Company by stockholders other than the Mutual Company ("Minority Stockholders"). Although OTS regulations and the Plan of Reorganization permit the Mutual Company to convert from the mutual to the capital stock form of organization, there can be no assurance when, if ever, a conversion of the Mutual Company will occur. Provisions in the Stock Company's and the Bank's Governing Instruments. In addition, certain provisions of the Stock Company's charter and bylaws, particularly a provision limiting voting rights, as well as certain federal regulations, assist the Stock Company in maintaining its status as an independent publicly owned corporation. These provisions provide for, among other things, supermajority voting, staggered boards of directors, noncumulative voting for directors, limits on the calling of special meetings of shareholders, and limits on the ability to vote common stock in excess of 5% of outstanding shares (except as to shares held by the Mutual Company and the ESOP). POSSIBLE DILUTION IN OWNERSHIP INTEREST Dividend Waivers by the Mutual Company. It has been the policy of many mutual holding companies to waive the receipt of dividends declared by their subsidiaries. OTS regulations require that mutual holding companies request OTS approval before they waive dividends. The OTS has generally permitted mutual holding companies to waive dividends under certain conditions. Management believes that one of the conditions to such permission would be that in the event the Mutual Company converts to stock form in the future (a "Conversion Transaction"), any waived dividends would reduce the percentage of the resulting entity's shares of common stock issued to Minority Stockholders in exchange for their shares of common stock. The Plan of Reorganization also provides for such an adjustment. See "Regulation--Holding Company Regulation--Conversion of the Mutual Company to Stock Form." The Mutual Company has not determined whether it will waive dividends declared by the Stock Company. There is no assurance that the Mutual Company will not waive the receipt of cash dividends, or that the OTS would approve the waiver of dividends should the Mutual Company request it to do so. Terms of Any Conversion Transaction. If the Mutual Company conducts a Conversion Transaction, the stock offering that would be conducted as part of the Conversion Transaction would include maximum purchase limitations that restrict the amount of stock that a person could purchase. Minority Stockholders would be likely to receive shares of the resulting entity in exchange for their shares of the Company's common stock. Under current OTS policy, the shares of the resulting entity that Minority Stockholders receive in exchange for their shares of the Company's common stock will be included in these maximum purchase limitations that apply to the stock offering. This means that certain Minority Stockholders may not be able to exercise subscription rights to purchase shares of common stock in that stock offering, and in certain circumstances, may be required by the OTS to divest shares of the Company's common stock. POSSIBLE DILUTIVE EFFECT OF ISSUANCE OF ADDITIONAL SHARES Various possible and planned issuances of common stock could dilute the interests of prospective stockholders of the Stock Company following consummation of the Reorganization, as noted below. The number of shares to be sold in the Reorganization may be increased as a result of an increase in the Estimated Valuation Range of up to 15% to reflect changes in the market and financial conditions and demand for the stock following the commencement of the Offering. In the event that the Estimated Valuation Range is so increased, it is expected that the Stock Company will issue up to 4,496,500 shares of common stock. An increase in the number of shares will decrease net income per share and stockholders' equity per share on a pro forma basis and will increase the Stock Company's consolidated stockholders' equity and net income. See "Capitalization" and "Pro Forma Data." 16 The recognition and retention plan that the Bank intends to implement no earlier than six months after the Reorganization (the "Recognition Plan") intends to acquire an amount of common stock equal to 4.0% of the shares of common stock issued in the Offering. Such shares of common stock may be acquired in the open market with funds provided by the Stock Company, if permissible, or from authorized but unissued shares of common stock. See "Pro Forma Data" and "Management the Bank--Recognition and Retention Plan." The Stock Company's stock option plan will reserve for future issuance pursuant to such plan a number of shares of common stock equal to an aggregate of 10% of the common stock sold in the Offering (159,800 shares, based on the midpoint of the Offering Range). See "Pro Forma Data" and "Management of the Bank--Stock Option Plan." POTENTIAL INCREASED COMPENSATION EXPENSES AFTER THE REORGANIZATION Management believes that the Bank's salaries and benefits expense is likely to increase following the Reorganization due to the ESOP, and the Recognition Plan that the Bank intends to implement no earlier than six months after the conclusion of the Reorganization. Generally accepted accounting principles will require the Stock Company to record compensation expense upon the vesting of shares of restricted stock awarded pursuant to the Recognition Plan and upon the commitment to release shares under the ESOP. In addition, generally accepted accounting principles will require the Stock Company to record compensation expense in an amount equal to the fair value of the shares committed to be released to employees from the ESOP. Accordingly, future increases and decreases in fair value of common stock committed to be released will have a corresponding effect on compensation expense related to the ESOP. To the extent that the fair value of the Bank's ESOP shares differ from the cost of such shares, the differential will be charged or credited to equity. STRONG COMPETITION WITHIN THE BANK'S MARKET AREA Competition in the banking and financial services industry is intense. In our market area, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Many of these competitors have substantially greater resources and lending limits than the Bank and may offer certain services that we do not or cannot provide. Our profitability depends upon our continued ability to successfully compete in our market area. RELIANCE ON LOCAL ECONOMY The Bank's four offices are located in Gaston County, North Carolina, and the Bank originates a large portion of its loans in Gaston County. Per capita income in Gaston County is below the per capita income for the Charlotte- Gastonia-Rock Hill Metropolitan Statistical Area (the "Charlotte MSA"). In addition, income growth and total population growth in Gaston County is projected to lag behind the income and population growth of the Charlotte MSA and the state of North Carolina over the next five years. The lower income levels and lower projected rates of growth in Gaston County could result in an increase in the number of delinquent or non-performing loans and reduce the value of the collateral securing such loans and otherwise adversely affect the Bank's lending opportunities, financial condition, and results of operations. UNCERTAINTY AS TO FUTURE GROWTH OPPORTUNITIES 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 primary market area. Our ability to grow through selective acquisitions of other financial institutions or branches of such institutions will depend on successfully identifying, acquiring and integrating such institutions or branches. We 17 cannot assure prospective purchasers of common stock that we will be able to generate internal growth or identify attractive acquisition candidates, make acquisitions on favorable terms or successfully integrate any acquired institutions or branches into the Stock Company. We currently have no specific plans, arrangements or understandings regarding any such expansions or acquisitions, nor have we established criteria to identify potential candidates for acquisition. ABSENCE OF MARKET FOR COMMON STOCK We have received conditional approval to have the Stock Company's common stock quoted on the Nasdaq National Market System under the symbol "GBNK" subject to compliance with certain conditions including a minimum market capitalization, and a minimum number of market makers and record holders. Trident Securities, Inc. has indicated its intention to make a market in the common stock, and based on our analysis of the results of recent conversion stock offerings we anticipate that the Stock Company will satisfy the requirements relating to the minimum market capitalization, number of market makers and record holders. If we are unable, for any reason, to list the Common Stock on the Nasdaq National Market, or to continue to be eligible for such listing, then we intend to list the Common Stock on the Nasdaq SmallCap Market under the same symbol, or on the American Stock Exchange, subject to the applicable listing criteria for such markets. There is no assurance that an active and liquid trading market for the Common Stock will develop. The absence of an active and liquid trading market may make it difficult to sell the common stock and may have an adverse effect on the price of the common stock. Purchasers should consider the potentially illiquid and long-term nature of their investment in the common stock. IRREVOCABILITY OF ORDERS; POTENTIAL DELAY IN COMPLETION OF OFFERINGS Orders submitted in the Offering are irrevocable without consent from the Bank. Funds submitted in connection with any purchase of common stock in the Offering will be held by the Stock Company until the completion or termination of the Reorganization, including any extension of the expiration date. Because completion of the Reorganization will be subject to an update of the Independent Valuation, among other factors, there may be one or more delays in the completion of the Reorganization. Subscribers will have no access to subscription funds and/or shares of common stock until the Reorganization is completed or terminated. CAPABILITY OF THE BANK'S DATA PROCESSING SOFTWARE TO ACCOMMODATE THE YEAR 2000 Like many financial institutions the Bank relies upon computers for the daily conduct of its business and for data processing generally. There is concern among industry experts that commencing on January 1, 2000, computers will be unable to "read" the new year and there may be widespread computer malfunctions. Management has begun an assessment of the electronic systems, programs, applications and other electronic components used in the operations of the Bank, and believes that the Bank has either programmed its hardware and software to be able to accurately recognize the year 2000, or implemented a plan pursuant to which the hardware and software will be programmed in the future. Management believes that significant additional costs will not be incurred in connection with the year 2000 issue, although there can be no assurances in this regard. Management continues to test the Bank's hardware and software to determine whether it will be able function accurately in the year 2000. 18 REGULATORY OVERSIGHT AND LEGISLATION The Bank and the Stock Company are subject to extensive regulation, supervision and examination by the OTS (our chartering authority), and by the FDIC as insurer of deposits up to applicable limits. The Bank is also a member of the Federal Home Loan Bank System and is subject to certain limited regulations promulgated by the Federal Home Loan Bank. As the holding company of the Bank, the Stock Company also will be subject to regulation and oversight by the OTS. Such regulation and supervision are intended primarily for the protection of the insurance fund and depositors. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities which are intended to strengthen the financial condition of the banking and thrift industries, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy 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, could have a material impact on the Bank, the Stock Company, and our operations. See "Regulation." On September 30, 1996, the Deposit Insurance Funds ("DIF") Act of 1996 was enacted into law. The DIF Act contemplates the development of a common charter for all federally chartered depository institutions and the abolition of separate charters for national banks and federal savings associations. It is not known what form the common charter may take and what effect, if any, the adoption of a new charter would have on the financial condition or results of operations of the Bank. See "Regulation--Federal Regulation of Savings Institutions." Legislation is proposed periodically providing for a comprehensive reform of the banking and thrift industries, and has included provisions that would (i) require federal savings associations to convert to a national bank or a state-chartered bank or thrift, (ii) require all savings and loan holding companies to become bank holding companies and (iii) abolish the OTS. It is uncertain when or if any of this type of legislation will be passed, and, if passed, in what form the legislation would be passed. As a result, management cannot accurately predict the possible impact of such legislation on the Bank. GASTON FEDERAL HOLDINGS, MHC The Mutual Company will be formed as a federal mutual holding company and will initially own 53% of the Stock Company's common stock. The Stock Company has not yet been formed, although the OTS has approved an application for the Mutual Company to become a savings and loan holding company. The Mutual Company will have all of the powers set forth in its federal charter and federal law and OTS regulations. The Mutual Company initially will not conduct any active business other than activities relating to its investment in a majority of the Common Stock and maintenance of books and records relating to its members. The Mutual Company does not intend to employ any persons other than its officers, although it may utilize the Bank's support staff from time to time. Federal law and OTS regulations, and the Plan of Reorganization, require that as long as the Mutual Company is in existence it must own a majority of the Stock Company's common stock. Federal law and OTS regulations, and the Plan of Reorganization, permit the Mutual Company to convert to the capital stock form of organization (a "Conversion Transaction"). The manner in which such a transaction would be conducted and the regulations and policy affecting such a transaction are described in "Regulation--Holding Company Regulation." Although many federal mutual holding companies waive the receipt of cash dividends declared by their subsidiaries, the Mutual Company has not determined whether or not it will do so, and intends to make such a determination at the time the Stock Company declares a dividend. OTS regulations require the Mutual Company to give the OTS prior written notice of any such waiver, and the conditions pursuant to which the OTS generally approves dividend waivers are described in "Regulation--Holding Company Regulation." The Mutual Company's Board of Directors will waive dividends paid by the Stock Company if the Board determines that such a waiver is in the Mutual Company's members' best interest because, among other reasons: (i) the Mutual Company has no need for the dividend considering its business operations; (ii) the cash that would be received could be invested by the Stock Company or the Bank at a more favorable rate of return; (iii) such waiver may increase the capital of the Bank 19 and enhance its business so that members will continue to have access to the offices and services of the Bank; and (iv) such waiver preserves the net worth of the Mutual Company through its principal asset (the Stock Company, and indirectly, the Bank), which would be available for distribution in the unlikely event of a voluntary liquidation of the Stock Company and the Bank after satisfaction of claims of depositors and creditors. The Board of Directors may consider other factors in determining whether such waiver is consistent with its fiduciary duties to members of the Mutual Company. Any waiver of dividends by the Mutual Company is likely to result in a downward adjustment to the ratio pursuant to which shares of Common Stock are exchanged for shares of the resulting company in a Conversion Transaction. The Mutual Company's Board of Directors will accept dividends paid by the Stock Company in an amount necessary to pay the Mutual Company's expenses, and will accept additional dividends if it determines that accepting such dividends is in the Mutual Company's members' best interest because, among other reasons: (i) the Mutual Company may increase its direct ownership of the Stock Company, and indirect ownership of the Bank, by using cash dividends to purchase additional shares of Common Stock in the open market from time to time; and (ii) such dividends may be used to promote activities that are in the interest of members and members' community of Gaston County. Any purchases of Common Stock by the Mutual Company will increase the percentage of the Stock Company's Common Stock held by the Mutual Company and, in a Conversion Transaction, will decrease the aggregate number of shares of the resulting company issued to Minority Stockholders in exchange for their shares of Common Stock. The Mutual Company's executive office will located at the administrative offices of the Bank, at 245 West Main Avenue, P.O. Box 2249, Gastonia, North Carolina 28053-2249. Its telephone number will be (704) 868-5200. GASTON FEDERAL BANCORP, INC. The Stock Company will be formed as a federal corporation and will own 100% of the Bank's common stock. The Stock Company has not yet been formed, and, accordingly, its financial statements are not included herein. The OTS has approved an application for the Stock Company to become a savings and loan holding company through the acquisition of all of the capital stock of the Bank to be issued and outstanding upon completion of the Reorganization. The Stock Company will have all of the powers set forth in its federal charter and federal law and OTS regulations. The Stock Company will retain up to 50% of the net proceeds of the offering. Part of the net proceeds will be used to fund a loan to the Bank's ESOP which is expected to purchase up to 8% of the common stock sold in the Offering. The remainder of the net proceeds will be used for general corporate purposes. The holding company structure will provide the Stock Company with greater flexibility than is currently available to the Bank to diversify its business activities, either through newly-formed subsidiaries or through acquisitions. The business activities of the Stock Company will be subject to the same restrictions under federal law as the Mutual Company. The Stock Company has no present plans regarding diversification, acquisitions or expansion. The Stock Company initially will not conduct any active business and does not intend to employ any persons other than its officers, although it may utilize the Bank's support staff from time to time. The Stock Company's executive office will be located at the administrative offices of the Bank, at 245 West Main Avenue, P.O. Box 2249, Gastonia, North Carolina 28053-2249. Its telephone number will be (704) 868-5200. GASTON FEDERAL SAVINGS AND LOAN ASSOCIATION The Bank was organized in 1904 as a state chartered building and loan association. The Bank's deposits are insured by the Savings Association Insurance Fund, as administered by the FDIC, up to the maximum amount permitted by law. The Bank is a community-oriented savings association engaged primarily in the business of accepting deposits from customers through its branch offices and investing those deposits, together with funds generated from operations and borrowings, in one- to four-family residential, multi-family residential and commercial 20 real estate loans, commercial business loans, construction loans and consumer loans, and investment and mortgage-backed securities. At September 30, 1997, the Bank had total assets of $173.5 million, total deposits of $145.4 million and total equity of $20.9 million. The Bank's business is described in more detail in "Business of the Bank." The Bank's executive office is located at 245 West Main Avenue, Gastonia, North Carolina 28053-2249. The Bank's telephone number is (704) 868-5200. REGULATORY CAPITAL COMPLIANCE At September 30, 1997, the Bank exceeded each of its regulatory capital requirements. Set forth below is a summary of the Bank's compliance with the OTS capital standards as of September 30, 1997, on an historical and pro forma basis assuming that the indicated number of shares were sold as of such date and receipt by the Bank of 50% of the net proceeds. For purposes of the table below, the amount expected to be borrowed by the ESOP and the cost of its shares expected to be acquired by the Recognition Plan are deducted from pro forma regulatory capital. See "Management of the Bank." 21
PRO FORMA AT SEPTEMBER 30, 1997, BASED UPON THE SALE OF --------------------------------------------------------------------------------- 1,358,300 SHARES 1,598,000 SHARES 1,837,700 SHARES AT ADJUSTED HISTORICAL AT AT MINIMUM OF AT MIDPOINT OF AT MAXIMUM OF MAXIMUM OF SEPTEMBER 30, 1997 OFFERING RANGE OFFERING RANGE OFFERING RANGE OFFERING RANGE --------------------------------------- ----------------- ----------------- --------------- PERCENT PERCENT PERCENT PERCENT PERCENT OF OF OF OF OF AMOUNT ASSETS (2) AMOUNT ASSETS (2) AMOUNT ASSETS (2) AMOUNT ASSETS (2) AMOUNT ASSETS(2) ------------------ ------------------ ------------------ ------------------ ----------------- (DOLLARS IN THOUSANDS) GAAP capital............. $ 20,868 12.03% $ 25,569 14.35% $26,456 14.77% $27,342 15.19% $28,362 15.67% Tangible capital: Tangible capital (3)... 19,890 11.52% 24,591 13.87% 25,478 14.29% 26,364 14.72% 27,384 15.20% Requirement............ 2,590 1.50 2,660 1.50 2,674 1.50 2,687 1.50 2,702 1.50 -------- ----- --------- ----- ------- ----- ------- ----- ------- ----- Excess............... $ 17,300 10.02% $ 21,930 12.37% $22,804 12.79% $23,678 13.22% $24,682 13.70% ======== ================================================================================== Core capital: Core capital (3)....... 19,890 11.52% 24,591 13.80% 25,478 14.23% 26,364 14.65% 27,384 15.13% Requirement(4)......... 5,179 3.00 5,320 3.00 5,347 3.00 5,374 3.00 5,404 3.00 -------- ----- -------- ----- ------- ----- ------- ----- ------- ----- Excess............... $ 14,711 8.52% $ 19,270 10.80% $20,131 11.23% $20,991 11.65% $21,980 12.13% ======== ===== ================================================================================= Risk-based capital: Risk-based capital (3)(5) 20,800 21.37% 25,501 25.51% 26,388 26.27% 27,274 27.02% 28,294 27.87% Requirement............ 7,786 8.00 7,997 8.00 8,306 8.00 8,076 8.00 8,122 8.00 -------- ----- --------- ----- ------- ----- ------- ----- ------- ----- Excess............... $ 13,014 13.37% $ 17,504 17.51% $18,351 18.27% $19,198 19.02% $20,172 19.87% ======== ===== ==================================================================================
- ---------- (1) As adjusted to give effect to an increase in the number of shares which could occur due to an increase in the Offering Range of up to 15% as a result of regulatory considerations, demand for the shares, or changes in market conditions or general financial and economic conditions following the commencement of the Offering. (2) Tangible capital levels are shown as a percentage of tangible assets. 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) Pro forma capital levels assume that the Bank funds the Recognition Plan purchases of a number of shares equal to 4% of the common stock sold in the Offering, the ESOP purchases 8% of the shares sold in the Offering, and the Mutual Company is capitalized with $100,000. See "Management of the Bank" for a discussion of the Recognition Plan and ESOP. (4) The current core capital requirement for savings associations is 3% of total adjusted assets. The OTS has proposed core capital requirements that would require a core capital ratio of 3% of total adjusted assets for thrifts that receive the highest supervisory rating for safety and soundness and a 4% to 5% core capital ratio requirement for all other thrifts. See "Regulation--Federal Regulation of Savings Institutions--Capital Requirements. (5) Assumes net proceeds are invested in assets that carry a risk-weighting equal to the average risk weighting of the Bank's risk weighted assets as of September 30, 1997. USE OF PROCEEDS Although the actual net proceeds from the sale of the common stock cannot be determined until the Offering is completed, it is presently anticipated, based on the assumptions set forth in "Pro Forma Data" that the net proceeds from the sale of the common stock will be as set forth in the following table.
NET OFFERING PROCEEDS BASED UPON THE SALE FOR $10.00 PER SHARE OF ------------------------------------------------------- 1,358,300 1,598,000 1,837,700 2,113,355 SHARES SHARES SHARES SHARES --------- --------- --------- --------- (DOLLARS IN THOUSANDS) Gross proceeds...................................... $ 13,583 $ 15,980 $ 18,377 $ 21,134 Expenses............................................ (722) (770) (818) (873) --------- --------- --------- --------- Estimated net proceeds.............................. $ 12,861 $ 15,210 $ 17,559 $ 20,261 ========= ========= ========= =========
22 The Stock Company will contribute 50% of the net proceeds of the Offering to the Bank. Such portion of net proceeds received by the Bank from the Stock Company will be added to the Bank's general funds which the Bank currently intends to utilize for general corporate purposes, including investments in short- and medium-term investments. The Bank also intends to utilize funds to increase its origination of mortgage, consumer and commercial business loans. The Bank may also use such funds for the expansion of its retail banking franchise, and to expand operations through acquisitions of other financial institutions, branch offices or other financial services companies. To the extent that the stock-based benefit programs which the Stock Company intends to adopt subsequent to the Offering are not funded with authorized but unissued shares of common stock of the Stock Company, the Stock Company or Bank may use net proceeds from the Offering to fund the purchase of stock to be awarded under such stock benefit programs. See "Risk Factors--Possible Dilutive Effect of Issuance of Additional Shares" and "Management of the Bank--Stock Option Plan" and "--Recognition and Retention Plan." The Stock Company intends to use a portion of the net proceeds it retains to make a loan directly to the ESOP to enable the ESOP to purchase 8% of the shares sold in the Offering. See "Management of the Bank--Employee Stock Ownership Plan and Trust." The remaining net proceeds retained by the Stock Company will initially be invested in short- and medium-term investments. The net proceeds retained by the Stock Company may also be used to support the future expansion of operations through branch acquisitions, the establishment of branch offices and the acquisition of financial institutions or their assets, or diversification into other banking related businesses. However, the Stock Company and the Bank have no current arrangements, understandings or agreements regarding any such transactions. Upon completion of the Reorganization, the Stock Company will be regulated as a multiple savings and loan holding company, and will be permitted to engage only in those activities that are permissible for multiple savings and loan holding companies under the HOLA and regulations of the OTS. See "Regulation --Holding Company Regulation." Upon completion of the Reorganization, the Board of Directors of the Stock Company will have the authority to repurchase stock, subject to statutory and regulatory requirements. Based upon facts and circumstances following the Reorganization and subject to applicable regulatory requirements, the Board of Directors may determine to repurchase stock in the future. Such facts and circumstances may include but not be limited to (i) market and economic factors such as the price at which the stock is trading in the market, the volume of trading, the attractiveness of other investment alternatives in terms of the rate of return and risk involved in the investment, and the opportunity to improve the Stock Company's return on equity; (ii) the avoidance of dilution to stockholders by not having to issue additional shares to cover the exercise of stock options or to fund employee stock benefit plans; and (iii) any other circumstances in which repurchases would be in the best interests of the Stock Company and its shareholders. In the event the Stock Company determines to repurchases stock, such repurchases may be made at market prices which may be in excess of the Subscription Price in the Offering. To the extent that the Stock Company repurchases stock at market prices in excess of the per share book value, such repurchases may have a dilutive effect upon the interests of existing stockholders. DIVIDEND POLICY Upon completion of the Offering, the Board of Directors of the Stock Company will have the authority to declare dividends on the common stock, subject to statutory and regulatory requirements. The Stock Company intends to pay an annual cash dividend of $.20, payable quarterly at $.05 per share. The payment of dividends is expected to begin following the first full quarter after the completion of the Reorganization. Dividends will be subject to determination and declaration by the Board of Directors in its discretion, which will take into account the Stock Company's consolidated financial condition and results of operations, tax considerations, industry standards, economic conditions, capital levels, regulatory restrictions on dividend payments by the Bank to the Stock Company, general business practices and other factors. The Stock Company will not be subject to OTS regulatory restrictions on the payment of dividends although the source of such dividends depend in 23 part upon the receipt of dividends from the Bank. The Bank must provide the OTS with 30 days prior notice of its intention to make a capital distribution to the Stock Company. OTS regulations in certain circumstances limit the amount of any capital distribution by federal savings associations. In addition, the portion of the Bank's earnings which has been appropriated for bad debt reserves and deducted for federal income tax purposes cannot be used by the Bank to pay cash dividends to the Stock Company without the payment of federal income taxes by the Bank at the then current income tax rate on the amount deemed distributed, which would include the amount of any federal income taxes attributable to the distribution. The Stock Company does not contemplate any distribution by the Bank that would result in a recapture of the Bank's bad debt reserve or otherwise create federal tax liabilities. See "Federal and State Taxation--Federal Taxation" and Note 7 to the Consolidated Financial Statements, and "Regulation--Federal Regulation of Savings Institutions--Limitations on Capital Distributions." Additionally, in connection with the Reorganization, the Stock Company and Bank have committed to the OTS that during the one-year period following the consummation of the Reorganization, the Stock Company will not declare an extraordinary dividend to stockholders which would be treated by recipient stockholders as a tax-free return of capital for federal income tax purposes without prior approval of the OTS. MARKET FOR COMMON STOCK We have received conditional approval to have the Stock Company's common stock quoted on the Nasdaq National Market System under the symbol "GBNK" subject to compliance with certain conditions including a minimum market capitalization, and a minimum number of market makers and record holders. Trident Securities, Inc. has indicated its intention to make a market in the common stock, and based on our analysis of the results of recent conversion stock offerings we anticipate that the Stock Company will satisfy the requirements relating to the minimum market capitalization, number of market makers and record holders. If we are unable, for any reason, to list the Common Stock on the Nasdaq National Market, or to continue to be eligible for such listing, then we intend to list the Common Stock on the Nasdaq SmallCap Market under the same symbol, or on the American Stock Exchange, subject to the applicable listing criteria for such markets. The existence of a public trading market will depend upon the presence in the market of both willing buyers and willing sellers at any given time. The presence of a sufficient number of buyers and sellers at any given time is a factor over which neither the Stock Company nor any broker or dealer has control. The absence of an active and liquid trading market may make it difficult to sell the common stock and may have an adverse effect on the price of the common stock. Purchasers should consider the potentially illiquid and long-term nature of their investment in the common stock. 24 CAPITALIZATION The following table presents the historical capitalization of the Bank at September 30, 1997, and the pro forma consolidated capitalization of the Stock Company after giving effect to the Offering, based upon the sale of the number of shares indicated in the table and the other assumptions set forth under "Pro Forma Data."
PRO FORMA CONSOLIDATED CAPITALIZATION BASED UPON THE SALE FOR $10.00 PER SHARE OF -------------------------------------------------------- 2,113,355 1,358,300 1,598,000 1,837,700 SHARES AT SHARES AT SHARES AT SHARES AT ADJUSTED MINIMUM OF MIDPOINT OF MAXIMUM MAXIMUM OF HISTORICAL OFFERING OFFERING OFFERING OFFERING CAPITALIZATION RANGE RANGE RANGE RANGE (1) -------------- ---------- ----------- ----------- -------------- (DOLLARS IN THOUSANDS) Deposits (2)............................ $ 145,444 $145,444 $ 145,444 $ 145,444 $145,444 FHLB advances........................... 3,500 3,500 3,500 3,500 3,500 --------- -------- --------- --------- -------- Total deposits and borrowed funds....... $ 148,944 $148,944 $ 148,944 $ 148,944 $148,944 ========= ======== ========= ========= ======== Stockholders' equity: Preferred Stock, $1.00 par value, 1,000,000 shares authorized; none to be issued (3) $ -- $ -- $ -- $ -- $ -- common stock, $1.00 par value per share: 10,000,000 shares authorized; shares to be issued as reflected.......... -- 2,890 3,400 3,910 4,497 Additional paid-in capital (3)........ -- 9,971 11,810 13,650 15,764 Retained earnings (4)................. 20,868 20,768 20,768 20,768 20,768 Less: Common Stock acquired by ESOP (5)... -- (1,087) (1,278) (1,470) (1,691) Common Stock acquired by Recognition Plan (6).............. -- (543) (639) (735) (845) --------- --------- ---------- ---------- --------- Total stockholders' equity........ $ 20,868 $ 31,999 $ 34,061 $ 36,122 $ 38,493 ========= ======== ========= ========= ======== Total stockholders' equity as a percentage of pro forma total assets.............. 12.0% 17.3% 18.2% 19.1% 20.1% ========= ======== ========= ========= ========
- ---------- (1) As adjusted to give effect to an increase in the number of shares which could occur due to a 15% increase in the Estimated Valuation Range to reflect changes in market or general financial conditions following the commencement of the Offering. (2) Does not reflect withdrawals from deposit accounts for the purchase of common stock in the Offering. Such withdrawals would reduce pro forma deposits by the amount of such withdrawals. (3) Reflects the sale of shares in the Offering. Does not include proceeds from the Offering that the Stock Company intends to lend to the ESOP to enable it to purchase shares of common stock in the Offering. No effect has been given to the issuance of additional shares of common stock pursuant to the stock option plan that the Stock Company expects to adopt. If such plan is approved by stockholders, an amount equal to 10% of the shares of common stock issued in the Offering will be reserved for issuance upon the exercise of options. See "Management of the Bank." (4) The retained earnings of the Bank will be substantially restricted after the Reorganization. See "Dividend Policy" and "Regulation--Federal Regulation of Savings Institutions--Limitations on Capital Distributions." Pro forma amounts are reduced by the $100,000 that will be used to capitalize the Mutual Company. Includes unrealized gains on securities available for sale, net of tax, of $1.0 million. (5) Assumes that 8% of the shares sold in the Offering will be purchased by the ESOP and that the funds used to acquire the ESOP shares will be borrowed from the Stock Company. The common stock acquired by the ESOP is reflected as a reduction of stockholders' equity. See "Management of the Bank--Employee Stock Ownership Plan and Trust." (6) Assumes that, subsequent to the Offering, an amount equal to 4% of the shares of common stock sold in the Offering is purchased by the Recognition Plan through open market purchases. The common stock to be purchased by the Recognition Plan is reflected as a reduction of stockholders' equity. See "Risk Factors--Dilutive Effect of Issuance of Additional Shares," "Pro Forma Data" and "Management of the Bank." The Recognition plan will not be implemented for at least six months after the Offering and until it has been approved by stockholders. 25 PRO FORMA DATA The actual net proceeds from the sale of the common stock cannot be determined until the Offering is completed. The following estimated pro forma information is based upon the following assumptions: (i) 300,000 shares of common stock will be purchased by employees and directors of the Bank and Company, the ESOP will purchase 8% of the common stock sold in the Offering, and the remaining shares will be sold in the Subscription and/or Community Offering; (ii) Trident Securities will receive a fee equal to 2.0% of the aggregate Subscription Price of shares sold to persons other than employees, directors and the ESOP; (iii) Reorganization expenses, excluding the fees payable to Trident Securities, will be approximately $450,000; and (v) the Mutual Company will be capitalized with $100,000. Actual expenses may vary from those estimated. Pro forma consolidated net income of the Stock Company for the year ended September 30, 1997 has been calculated as if the common stock had been sold at the beginning of the period and the net proceeds had been invested at 5.44% (the one year U.S. Treasury bill rate as of September 30, 1997). The U.S. Treasury rate was used on the reinvestment of proceeds because it more appropriately reflects a market rate of return than the arithmetic average of the average yield of the Bank's interest-earning assets and cost of deposits. The tables do not reflect the effect of withdrawals from deposit accounts for the purchase of common stock. The pro forma after-tax yield for the Stock Company and the Bank is assumed to be 3.48% for the fiscal year ended September 30, 1997 (based on an assumed tax rate of 36%). 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, as adjusted to give effect to the purchase of shares by the ESOP. No effect has been given in the pro forma stockholders' equity calculations for the assumed earnings on the net proceeds. As discussed under "Use of Proceeds," the Stock Company will retain 50% of the net proceeds from the 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 amount of assets and liabilities of the Stock Company. The pro forma stockholders' equity is not intended to represent the fair market value of the common stock and may be greater than amounts that would be available for distribution to stockholders in the event of liquidation. 26 The following tables summarize historical data of the Bank and pro forma data of the Stock Company at or for the fiscal year ended September 30, 1997, based on the assumptions set forth above and in the table and should not be used as a basis for projections of market value of the common stock following the Offering. The tables below give effect to the Recognition Plan, which is expected to be adopted by the Stock Company following the Offering and presented to stockholders for approval. See"Management of the Bank--Recognition and Retention Plan." No effect has been given in the tables to the possible issuance of additional shares reserved for future issuance pursuant to the stock option plan to be adopted by the Board of Directors of the Stock Company and presented to stockholders for approval, nor does stockholders' equity as presented give any effect to the tax effect of the bad debt reserve and other factors. See"Management of the Bank--Stock Option Plan."
AT OR FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997 BASED UPON THE SALE FOR $10.00 PER SHARE OF --------------------------------------------------------- 1,358,300 1,598,000 1,837,700 2,113,355 SHARES SHARES SHARES SHARES (1) ----------- ----------- ----------- ----------- (DOLLARS AND NUMBER OF SHARES IN THOUSANDS) Gross proceeds...................................... $ 13,583 $ 15,980 $ 18,377 $ 21,134 Expenses............................................ (722) (770) (818) (873) --------- --------- --------- --------- Estimated net proceeds............................ 12,861 15,210 17,559 20,261 Common Stock purchased by ESOP (2)................ (1,087) (1,278) (1,470) (1,690) Common Stock purchased by Recognition Plan (3).... (543) (639) (735) (845) --------- ---------- --------- --------- Estimated net proceeds.......................... $ 11,231 $ 13,293 $ 15,354 $ 17,725 ========= ========= ========= ========= FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997: Net income: Historical........................................ $ 1,432 $ 1,432 $ 1,432 $ 1,432 Pro forma adjustments: Income on net proceeds............................ 391 463 534 617 ESOP (2).......................................... (70) (82) (94) (108) Recognition Plan (3).............................. (70) (82) (94) (108) --------- --------- --------- --------- Pro forma net income............................ $ 1,683 $ 1,731 $ 1,778 $ 1,833 ========= ========= ========= ========= Net income per share: Historical........................................ $ 0.51 $ 0.44 $ 0.38 $ 0.33 Pro forma adjustments: Income on net proceeds............................ 0.14 0.14 0.14 0.14 ESOP (2).......................................... (0.02) (0.02) (0.02) (0.02) Recognition Plan (3).............................. (0.02) (0.02) (0.02) (0.02) --------- --------- --------- --------- Pro forma net income per share (2)(3)(4)........ $ 0.61 $ 0.53 $ 0.48 $ 0.43 ========= ========= ========= ========= Price to pro forma earnings......................... 16.95x 19.18x 20.75x 23.12x ========= ========= ========= ========= AT SEPTEMBER 30, 1997: Stockholders' equity: Historical........................................ $ 20,768 $ 20,768 $ 20,768 $ 20,768 Estimated net proceeds............................ 12,861 15,210 17,559 20,261 Less: Common Stock acquired by ESOP (2)........... (1,087) (1,278) (1,470) (1,691) Common Stock acquired by Recognition Plan (3)................................ (543) (639) (735) (845) --------- --------- ---------- --------- Pro forma stockholders' equity (5).............. 31,999 34,061 36,122 38,493 --------- --------- --------- --------- Pro form tangible stockholders' equity........... $ 31,999 $ 34,061 $ 36,122 $ 38,493 ========= ========= ========= ========= Stockholders' equity per share: Historical........................................ $ 7.19 $ 6.11 $ 5.31 $ 4.62 Estimated net proceeds............................ 4.45 4.47 4.49 4.51 Less: Common stock acquired by ESOP (2)........... (0.38) (0.38) (0.38) (0.38) Common stock acquired by Recognition Plan (3)................................ (0.19) (0.19) (0.19) (0.19) Pro forma stockholders' equity per share (5)..... 11.07 10.02 9.24 8.56 --------- --------- --------- --------- Pro forma tangible stockholders' equity per share(3)(4)..................................... $ 11.07 $ 10.02 $ 9.24 $ 8.56 ========= ========= ========= ========= Offering price as a percentage of pro forma stockholders' equity per share.................................. 90.31% 99.82% 108.24% 116.81% ========= ========= ========= =========
(Footnotes begin on next page) 27 - ---------- (1) As adjusted to give effect to an increase in the number of shares which could occur due to a 15% increase in the Estimated Valuation Range to reflect changes in market or general financial conditions following the commencement of the Offering. (2) It is assumed that 8% of the shares sold in the Offering will be purchased by the ESOP. For purposes of this table, the funds used to acquire such shares are assumed to have been borrowed by the ESOP from the Stock Company. The amount to be borrowed is reflected as a reduction of stockholders' equity. The Bank intends to make annual contributions to the ESOP in an amount at least equal to the principal and interest requirement of the debt. The Bank's total annual payment of the ESOP debt is based upon ten equal annual installments of principal, with an assumed interest rate of 8.5%. The pro forma net earnings information makes the following assumptions: (i) the Bank's contribution to the ESOP is equivalent to the debt service requirement for a full year and was made at the end of the period; (ii) 10,866, 12,784, 14,696 and 16,907 shares at the minimum, midpoint, maximum and adjusted maximum of the Offering Range, respectively, were committed to be released during the year ended September 30, 1997, at an average fair value of $10.00 per share in accordance with Statement of Position ("SOP") 93-6; and (iii) only the ESOP shares committed to be released were considered outstanding for purposes of the net earnings per share calculations. See "Management of the Bank--Employee Stock Ownership Plan and Trust." (3) Gives effect to the Recognition Plan expected to be adopted by the Stock Company following the Offering. This plan intends to acquire a number of shares of common stock equal to 4% of the shares sold in the Offering, or 54,332, 63,920, 73,508, and 84,534 shares of common stock at the minimum, midpoint, maximum and adjusted maximum of the Offering Range, respectively, either through open market purchases, if permissible, or from authorized but unissued shares of common stock or treasury stock of the Stock Company, if any. Funds used by the Recognition Plan to purchase the shares will be contributed to the plan by the Bank. In calculating the pro forma effect of the Recognition Plan, it is assumed that the shares were acquired by the plan in open market purchases at the beginning of the period presented for a purchase price equal to the Subscription Price, and that 20% of the amount contributed was an amortized expense during the period. The issuance of authorized but unissued shares of the Stock Company's common stock to the Recognition Plan instead of open market purchases would dilute the voting interests of existing stockholders by approximately 4% and pro forma net earnings per share would be $0.60, $0.52, $0.47 and $0.42 at the minimum, midpoint, maximum and adjusted maximum of the Offering Range, respectively, and pro forma stockholders' equity per share would be $11.05, $10.02, $9.25 and $8.60 at the minimum, midpoint, maximum and adjusted maximum of the Offering Range, respectively. There can be no assurance that the actual purchase price of the shares granted under the Recognition Plan will be equal to the Subscription Price. See "Management of the Bank--Recognition and Retention Plan." (4) No effect has been given to the issuance of additional shares of common stock pursuant to the stock option plan expected to be adopted by the Stock Company following the Offering. Under the stock option plan, an amount equal to 10% of the common stock sold in the Offering, or 135,830, 159,800, 183,770 and 211,335 shares at the minimum, midpoint, maximum and adjusted maximum of the Offering Range, respectively, will be reserved for future issuance upon the exercise of options to be granted under the stock option plan. The issuance of common stock pursuant to the exercise of options under the stock option plan will result in the dilution of existing stockholders' interests. Assuming all options were exercised at the end of the period at an exercise price equal to the Subscription Price, existing stockholders' voting interest would be diluted by 4.5%, and at the minimum, midpoint, maximum and adjusted maximum of the Offering Range the pro forma net earnings per share would be $0.56, $0.49, $0.44 and $0.40, respectively, and the pro forma stockholders' equity per share would be $11.02, $10.02, $9.27 and $8.63, respectively. See "Management of the Bank--Stock Option Plan." (5) The retained earnings of the Bank will continue to be substantially restricted after the Offering. See "Dividend Policy" and "Regulation--Federal Regulation of Savings Institutions." 28 PARTICIPATION BY MANAGEMENT The following table sets forth information regarding intended common stock subscriptions by each of the Directors and executive officers of the Bank and Directors of the Stock Company who do not serve as directors of the Bank and their families, and by all such Directors and executive officers as a group. In the event the individual maximum purchase limitation is increased, persons subscribing for the maximum amount may increase their purchase order. This table excludes shares to be purchased by the ESOP, as well as any Recognition Plan awards or stock option grants that may be made no earlier than six months after the completion of the Reorganization. See "Management of the Bank--Recognition and Retention Plan" and "--Stock Option Plan."
Percent of Shares Issued Position in the Name With the Bank Total Shares(1) Aggregate Price Offering(2) ---- ------------- --------------- --------------- ------------- Sen. David W. Hoyle Chairman 25,000 250,000 1.6% Ben R. Rudisill, III Vice Chairman 25,000 250,000 1.6 Robert W. Williams Vice Chairman 25,000 250,000 1.6 Martha B. Beal Director 25,000 250,000 1.6 James J. Fuller Director 10,000 100,000 * William H. Keith Director 5,000 50,000 * Charles D. Massey Director 25,000 250,000 1.6 Eugene R. Matthews, II Director 25,000 250,000 1.6 Kim S. Price President, Chief 25,000 250,000 1.6 Executive Officer Paul L. Teem, Jr. Executive Vice 25,000 250,000 1.6 President, Secretary, Chief Operations Officer Gary F. Hoskins Vice President, Treasurer 20,000 200,000 1.3 and Chief Financial Officer ------- ---------- ---- All directors and executive officers 235,000 $2,350,000 14.7% as a group (11 persons) ======= ========== ====
- ---------------- *Less than 1%. (1) The maximum number of shares for which any officer or director may subscribe is 25,000 shares. (2) At the midpoint of the Offering Range. 29 THE REORGANIZATION AND OFFERING THE OTS HAS APPROVED THE PLAN AND THE OFFERING OF THE COMMON STOCK SUBJECT TO THE APPROVAL OF THE BANK'S MEMBERS AND THE SATISFACTION OF CERTAIN CONDITIONS IMPOSED BY THE OTS. HOWEVER, SUCH APPROVAL DOES NOT CONSTITUTE A RECOMMENDATION OR ENDORSEMENT OF THE OFFERING OR THE PLAN BY THE OTS. DESCRIPTION OF AND REASONS FOR THE REORGANIZATION Our Board of Directors unanimously adopted the Plan and the OTS has approved the Plan. Pursuant to our Plan, we will reorganize into what we call a "two-tier" mutual holding company structure. We call it a two-tier structure because we will have two levels of holding companies--a "mid-tier" stock holding company and a "top-tier" mutual holding company. Under the terms of the Plan (i) we will form the company as a federal corporation; (ii) we will form the Mutual Company as a federal mutual holding company; (iii) we will reorganize the Bank into the capital stock form of organization and issue 100% of our to-be outstanding common stock to the Stock Company; and (iv) the Stock Company will issue shares of common stock to the public and the Mutual Company. The number of shares of common stock sold to the public pursuant to this Prospectus will be equal to 47% of the shares issued in the Reorganization and the number of shares issued to the Mutual Company will be equal to 53% of the shares issued in the Reorganization. In this Prospectus we will refer to all of these steps that are part of this transaction as the "Reorganization," and we will refer to the issuance of 47% of the Stock Company's common stock pursuant to this Prospectus as the "Offering." The two-tier mutual holding company structure is most easily understood by considering the following schematic: [Company Structure Chart appears below] The Mutual Public Company Stockholders (a federal mutual holding company) 53% of the 47% of the common common stock stock The Stock Company (a federal corporation) 100% of the common stock The Bank (a federal stock savings bank) In adopting the Plan, our Board of Directors determined that the Reorganization is in the best interest of the Bank. The primary purpose of the Reorganization is to establish a structure that will enable us to compete and expand more effectively in the financial services marketplace, and that will enable our depositors, employees, management and directors to obtain an equity ownership interest in the Bank. Our new structure will permit the Stock Company to issue capital stock, which is a source of capital not available to mutual savings banks, and we will take advantage of this new ability by issuing common stock in the Offering. Since the Stock Company is not offering all of its 30 common stock for sale to depositors and the public in the Offering (but is issuing a majority of its stock to the Mutual Company), the Reorganization will result in less capital raised in comparison to a standard mutual-to-stock conversion. The Reorganization, however, will also offer the Bank the opportunity to raise additional capital since the stock held by the Mutual Company will be available for sale in the future in the event of the Mutual Company decides to convert to the capital stock form of organization. See "Regulation--Holding Company Regulation--Conversion of the Mutual Company to Stock Form." The Reorganization will also give us greater flexibility to structure and finance the expansion of our operations, including the potential acquisition of other financial institutions, and to diversify into other financial services. The holding company form of organization is expected to provide additional flexibility to diversify the Bank's business activities through existing or newly formed subsidiaries, or through acquisitions of or mergers with other financial institutions, as well as other companies. Although we have no current arrangements, understandings or agreements regarding any such opportunities, the Stock Company will be in a position after the Reorganization, subject to regulatory limitations and the Stock Company's financial position, to take advantage of any such opportunities that may arise. Lastly, the Reorganization will enable us to better manage our capital by giving us broader investment opportunities through the holding company structure, and enable us to distribute capital to stockholders of the Stock Company in the form of dividends and stock repurchases. Because only a minority of the common stock will be offered for sale in the Offering, our current mutual form of ownership and our ability to remain an independent savings bank and to provide community-oriented financial services will be preserved through the mutual holding company structure. The Board of Directors believes that these advantages outweigh the potential disadvantages of the mutual holding company structure, which may include: (i) the inability of stockholders other than the Mutual Company to obtain majority ownership of the Stock Company and the Bank, which may result in the perpetuation of the management and Board of Directors of the Bank and the Stock Company; and (ii) that the mutual holding company structure is a relatively new form of corporate ownership, and new regulatory policies relating to the mutual interest in the Mutual Company that may be adopted from time-to-time may have an adverse impact on minority stockholders. A majority of the voting stock of the Stock Company will be owned by the Mutual Company, which is a mutual institution that will be controlled by members. While this structure will permit management to focus on the Stock Company's and the Bank's long-term business strategy for growth and capital redeployment without undue pressure from stockholders, it will also serve to perpetuate the existing management and directors of the Bank. The Mutual Company will be able to elect all members of the Board of Directors of the Stock Company, and will be able to control the outcome of all matters presented to the stockholders of the Stock Company for resolution by vote except for certain matters that must be approved by more than a majority of stockholders of the Stock Company. No assurance can be given that the Stock Company will not take action adverse to the interests of the Minority Stockholders. For example, the Stock Company could revise the dividend policy or defeat a candidate for the Board of Directors of the Bank or other proposals put forth by the Minority Stockholders. The Reorganization does not preclude the conversion of the Mutual Company from the mutual to stock form of organization. A conversion of the Mutual Company from the mutual to stock form of organization is not anticipated for the foreseeable future. See "Regulation--Holding Company Regulation-- Conversion of the Mutual Company to Stock Form." Following the completion of the Reorganization, all members of Bank as of the effective date of the Reorganization will become members of the Mutual Company so long as they continue to hold deposit accounts with the Bank. In addition, all persons who become depositors subsequent to the Reorganization will become members of the Mutual Company. All insured deposit accounts of the Bank that are transferred to the Stock Bank will continue to be federally insured by the FDIC and the SAIF up to the legal maximum limit in the same manner as deposit accounts existing in the Bank immediately prior to the Reorganization. Upon completion of the Reorganization, the Bank may exercise 31 any and all powers, rights and privileges of, and shall be subject to all limitations applicable to, capital stock savings banks under federal law and OTS regulations. Although the Stock Company will have the power to issue shares of capital stock to persons other than the Mutual Company, as long as the Mutual Company is in existence, the Mutual Company will be required to own a majority of the voting stock of the Stock Company. The Stock Company may issue any amount of non-voting stock to persons other than the Mutual Company and the Stock Company must own 100% of the voting stock of the Bank. The Bank and the Stock Company may issue any amount of non-voting stock or debt to persons other than the Mutual Company. STOCK PRICING AND NUMBER OF SHARES TO BE ISSUED IN THE REORGANIZATION AND OFFERING The Plan of Conversion and federal and state regulations require that the aggregate purchase price of the common stock issued in the Offering must be based on the appraised pro forma market value of the common stock, as determined by an independent valuation. The Bank has retained Feldman Financial, which has prepared the Independent Valuation. For its services in making such appraisal, Feldman Financial will receive a fee of $17,500 (which amount does not include a fee of $5,000 to be paid to Feldman Financial for assistance in preparation of a business plan). The Bank and the Stock Company have agreed to indemnify Feldman Financial and its employees and affiliates against certain losses (including any losses in connection with claims under the federal securities laws) arising out of its services as appraiser, except where Feldman Financial's liability results from its negligence or bad faith. The Independent Valuation was prepared by Feldman Financial in reliance upon the information contained in the Prospectus, including the Consolidated Financial Statements. Feldman Financial also considered the following factors, among others: the present and projected operating results and financial condition of the Bank and the economic and demographic conditions in the Bank's existing marketing area; certain historical, financial and other information relating to the Bank; a comparative evaluation of the operating and financial statistics of the Bank with those of other publicly traded savings institutions located in the Southeast region and on a national basis; the aggregate size of the Offering; the impact of the Reorganization on the Bank's stockholders' equity and earnings potential; the proposed dividend policy of the Stock Company; and the trading market for securities of comparable institutions and general conditions in the market for such securities. The Independent Valuation states that as of December 11, 1997, the estimated pro forma market value of the common stock ranged from a minimum of $28,900,000 to a maximum of $39,100,000 with a midpoint of $34,000,000 (the "Estimated Valuation Range"). The Bank's Board of Directors determined to the offer the shares in the Offering for the Subscription Price of $10.00 per share. Based on the Estimated Valuation Range and the Subscription Price, the number of shares of common stock that the Stock Company will issue will range from between 2,890,000 shares to 3,910,000 shares, with a midpoint of 3,400,000 shares. The Bank's Board of Directors determined offer 47% of such shares in the Offering, or between 1,350,300 shares and 1,837,700 shares with a midpoint of 1,598,000 shares (the "Offering Range"). The 53% of the to-be outstanding shares of common stock that are not sold in the Offering will be issued to the Mutual Company. The Board of Directors reviewed the Independent Valuation and, in particular, considered (i) the Bank's financial condition and results of operations for the year ended September 30, 1997,(ii) financial comparisons of the Bank in relation to financial institutions of similar size and asset quality, and (iii) stock market conditions generally and in particular for financial institutions, all of which are set forth in the Independent Valuation. The Board also reviewed the methodology and the assumptions used by Feldman Financial in preparing the Independent Valuation. The Estimated Valuation Range may be amended with the approval of the OTS (if required), if necessitated by subsequent developments in the financial condition of the Bank or market conditions generally. In the event the Independent Valuation is updated to increase the pro forma market value of the common stock to more than $44,965,000 or less than $28,900,000, such appraisal will be filed with the Securities and Exchange Commission by post-effective amendment. 32 Following commencement of the Subscription Offering, the maximum of the Estimated Valuation Range may be increased by up to 15% to up to 44,965,000, which will result in a corresponding increase in the maximum of the Offering Range to up to 2,113,355 shares to reflect changes in the market and financial conditions, without the resolicitation of subscribers. The minimum of the Estimated Valuation Range and the minimum of the Offering Range may not be decreased without a resolicitation of subscribers. The Subscription Price of $10.00 per share will remain fixed. See "--Limitations on Purchases of Common Stock" 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 Subscription and Community Offerings. THE INDEPENDENT VALUATION, HOWEVER, IS NOT INTENDED, AND MUST NOT BE CONSTRUED, AS A RECOMMENDATION OF ANY KIND AS TO THE ADVISABILITY OF PURCHASING SUCH SHARES. FELDMAN FINANCIAL DID NOT INDEPENDENTLY VERIFY THE CONSOLIDATED FINANCIAL STATEMENTS AND OTHER INFORMATION PROVIDED BY THE BANK, NOR DID FELDMAN FINANCIAL VALUE INDEPENDENTLY THE ASSETS OR LIABILITIES OF THE BANK. THE INDEPENDENT VALUATION CONSIDERS THE BANK AS A GOING CONCERN AND SHOULD NOT BE CONSIDERED AS AN INDICATION OF THE LIQUIDATION VALUE OF THE BANK. 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 PURCHASING SUCH SHARES IN THE OFFERING WILL THEREAFTER BE ABLE TO SELL SUCH SHARES AT PRICES AT OR ABOVE THE SUBSCRIPTION PRICE. The Independent Valuation will be updated at the time of the completion of the Offering. If the update to the Independent Valuation at the conclusion of the Offering results in an increase in the maximum of the Estimated Valuation Range to more than $44,965,000 and a corresponding increase in the Offering Range to more than 2,113,355 shares, or a decrease in the minimum of the Estimated Valuation Range to less than $28,900,000 and a corresponding decrease in the Offering Range to fewer than 1,358,300 shares, then the Stock Company, after consulting with the OTS, may terminate the Plan of Reorganization and return all funds promptly with interest at the Bank's passbook rate of interest on payments made by check, certified or teller's check, bank draft or money order, extend or hold a new Subscription Offering, Community Offering, or both, establish a new Estimated Valuation Range and Offering Range, commence a resolicitation of subscribers or take such other actions as permitted by the OTS in order to complete the Reorganization and the Offering. In the event that a resolicitation is commenced, unless an affirmative response is received within a reasonable period of time, all funds will be promptly returned to investors as described above. A resolicitation, if any, following the conclusion of the Subscription and Community Offerings would not exceed 45 days unless further extended by the OTS for periods of up to 90 days not to extend beyond 24 months following the Special meeting, or ____________, 2000. An increase in the Independent Valuation and the number of shares to be issued in the Offering would decrease both a subscriber's ownership interest and the Stock Company's pro forma earnings and stockholders equity on a per share basis while increasing pro forma earnings and stockholder's equity on an aggregate basis. A decrease in the Independent Valuation and the number of shares to be issued in the Offering would increase both a subscriber's ownership interest and the Stock Company's pro forma earnings and stockholder's equity on a per share basis while decreasing pro forma net income and stockholder's equity on an aggregate basis. For a presentation of the effects of such changes, see "Pro Forma Data." Copies of the appraisal report of Feldman Financial and the detailed memorandum of the appraiser setting forth the method and assumptions for such appraisal are available for inspection at the main office of the Bank and the other locations specified under "Additional Information." No sale of shares of common stock may be consummated unless, prior to such consummation, Feldman Financial confirms to the Bank and the OTS that, to the best of its knowledge, nothing of a material nature has occurred that, taking into account all relevant factors, would cause Feldman Financial to conclude that the Independent Valuation is incompatible with its estimate of the pro forma market value of the common stock of the Stock Company at the conclusion of the Offering. Any change that would result in an aggregate purchase price that is below the minimum or above the maximum of the Estimated Valuation Range would be subject to OTS approval. If such 33 confirmation is not received, the Bank may extend the Offering, reopen or commence a new offering, establish a new Estimated Valuation Range and commence a resolicitation of all purchasers with the approval of the OTS or take such other actions as permitted by the OTS in order to complete the Offering. PURCHASE PRIORITIES AND METHOD OF OFFERING SHARES IN THE OFFERING Concurrent with the Reorganization, the Stock Company is offering shares of common stock to persons other than the Mutual Company. An offering of between 1,358,300 and 1,837,700 shares of the common stock (subject to adjustment to up to 2,113,355 shares in the event of an increase in the maximum of the Estimated Valuation Range. The shares of common stock that will be sold in the Offering will constitute no more than 47% of the shares that will be outstanding immediately at the conclusion of the Offering. Following the Reorganization and the Offering, the Stock Company also will be authorized to issue additional common stock or preferred stock to persons other than the Mutual Company, without prior approval of the holders of the common stock. Subject to the preceding paragraph and the limitations set forth in the "--Limitations upon Purchases of Common Stock" section, the priorities for the purchase of shares are as follows: Priority 1: Eligible Account Holders. Each depositor with aggregate savings account balances of $50 or more (a "Qualifying Deposit") as of March 31, 1996 (the "Eligibility Record Date," and such account holders, "Eligible Account Holders") will receive, without payment therefor, nontransferable subscription rights to subscribe for up to the greater of 25,000 shares, .10% of the total offering of shares, or 15 times the product (rounded down to the next whole number) obtained by multiplying the total number of shares to be issued in the Offering by a fraction of which the numerator 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 overall purchase limitation and exclusive of shares purchased by the ESOP from any increase in the shares offered pursuant to an increase in the maximum of the Offering Range. See "--Limitations on Common Stock Purchases." If there are not sufficient shares available to satisfy all subscriptions, shares first will 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 (except for additional shares issued to the ESOP upon an increase in the maximum of the Offering Range) will be allocated to each subscribing Eligible Account Holder whose subscription remains unfilled in the proportion that the amount of his aggregate 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. Additional shares issued in the event of an increase in the maximum of the Offering Range will be sold first to the ESOP. To ensure proper allocation of stock, each Eligible Account Holder must list on his Order Form all deposit accounts in which he has an ownership interest on the Eligibility Record Date. Failure to list an account could result in 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 the Bank 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 the Eligibility Record Date. For allocation purposes, Qualifying Deposits will be divided in the case of multiple orders. Priority 2: Employee Plans. To the extent that there are sufficient shares remaining after satisfaction of subscriptions by Eligible Account Holders, the ESOP will receive, without payment therefor, nontransferable subscription rights to purchase Common Stock in the Offering on behalf of ESOP participants subject to the purchase limitations described herein. The ESOP intends to subscribe for 8% of the Common Stock issued in the Offering, including 8% of the total number of shares issued if the maximum of the Offering Range is increased. Priority 3: Supplemental Eligible Account Holders. To the extent that there are sufficient shares remaining after satisfaction of subscriptions by Eligible Account Holders and the ESOP, each depositor with a Qualifying Deposit 34 as of December 31, 1997 (the "Supplemental Eligibility Record Date") who is not an Eligible Account Holder ("Supplemental Eligible Account Holder") will receive, without payment therefor, nontransferable subscription rights to subscribe for the greater of up to 25,000 shares, .10% of the total offering of shares, or 15 times the product (rounded down to the next whole number) obtained by multiplying the number of shares issued in the Offering by a fraction of which the numerator 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 overall purchase limitation. See "--Limitations on Common Stock Purchases." If there are not sufficient shares available to satisfy all subscriptions, shares first 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 and 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 Order Form all deposit accounts in which he has an ownership interest on the Supplemental Eligibility Record Date. Failure to list an account could result in less shares being allocated than if all accounts had been disclosed. For allocation purposes, Qualifying Deposits will be divided in the case of multiple orders. Priority 4: Other Members. To the extent that there are shares remaining after satisfaction of subscriptions by Eligible Account Holders, the Employee Plans, and Supplemental Eligible Account Holders, each depositor with a Qualifying Deposit or a loan outstanding on the Voting Record Date ("Other Members") will receive, without payment therefor, nontransferable subscription rights to subscribe for up to the greater of 25,000 shares, or .10% of the total offering of shares, subject to the overall purchase limitation. See "--Limitations on Stock Purchases." If there are not sufficient shares available to satisfy all subscriptions, available shares will be allocated in proportion to the amounts of the subscriptions. COMMUNITY OFFERING Any shares of common stock not subscribed for in the Subscription Offering may be offered for sale in a Community Offering. This will involve an offering of unsubscribed shares directly to the general public for the Subscription Price of $10.00 per share. If a Community Offering is conducted, it will be for a period of not more than 45 days unless extended by the Stock Company and the Bank, and may commence concurrently with, during or promptly after the Subscription Offering. The common stock will be offered and sold in the Community Offering, in accordance with OTS regulations, so as to achieve the widest distribution of the common stock. No person, by himself or herself, or with an associate or group of persons acting in concert, may subscribe for or purchase more than $250,000 of common stock offered in the Community Offering. Further, the Stock Company may limit total subscriptions so as to assure that the number of shares available for the public offering may be up to a specified percentage of the number of shares of common stock. Finally, the Stock Company may reserve shares offered in the Community Offering for sales to institutional investors. In the event of an oversubscription for shares in the Community Offering, shares may be allocated in the sole discretion of the Bank (to the extent shares remain available) first to cover any reservation of shares for a Community Offering, or institutional orders, next to cover orders of natural persons residing in the Bank's local community of Gaston County, North Carolina (the "Community"), then to cover the orders of any other person subscribing for shares in the Community Offering so that each such person may receive 1,000 shares, and thereafter, on a pro rata basis to such persons based on the amount of their respective subscriptions. The terms "residence," "reside," "resided" or "residing" as used herein with respect to any person shall mean any person who occupied a dwelling within the Bank's Community, has an 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 35 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, the circumstances of the director 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 Bank. The Bank and the Stock Company, in their sole discretion, may reject subscriptions, in whole or in part, received from any person. SYNDICATED COMMUNITY OFFERING Depending on market conditions, the common stock may be offered for sale (for the Subscription Price of $10.00 per share) to the general public on a best efforts basis in the Syndicated Community Offering by a selling group (the "Selling Group") of broker-dealers ("Selected Dealers") to be managed by Trident Securities. Trident Securities, in its discretion, will instruct Selected Dealers as to the number of shares to be allocated to each Selected Dealer. Only upon allocation of shares to Selected Dealers may Selected Dealers take orders from their customers. Investors who desire to purchase shares in the Community Offering directly through a Selected Dealer, which may include Trident Securities, are advised that the members of the Selling Group are required either (a) upon receipt of an executed Order Form or direction to execute an Order Form on behalf of an investor, to forward the appropriate purchase price to the Bank for deposit in a segregated account on or before twelve noon, prevailing time, of the business day next following such receipt or execution; or (b) upon receipt of confirmation by such member of the Selling Group of an investor's interest in purchasing shares, and following a mailing of an acknowledgment by such member to such investor on the business day next following receipt of confirmation, to debit the account of such investor on the fifth business day next following receipt of confirmation and to forward the appropriate purchase price to the Bank for deposit in the segregated account on or before twelve noon, prevailing time, of the business day next following such debiting. Payment for any shares purchased pursuant to alternative (a) above must be made by check in full payment therefor. Payment for shares purchased pursuant to alternative (b) above may be made by wire transfer to the Bank. It is expected that the Syndicated Community Offering will commence as soon as practicable after termination of the Subscription Offering and the Community Offering, if any. The Syndicated Community Offering shall be completed within 45 days after the termination of the Subscription Offering, unless such period is extended as provided herein. If for any reason a Syndicated Community Offering of unsubscribed shares of common stock cannot be effected and any shares remain unsold after the Subscription Offering and the Community Offering, if any, the Boards of Directors of the Stock Company and the Bank will seek to make other arrangements for the sale of the remaining shares. Such other arrangements will be subject to the approval of the OTS and to compliance with applicable state and federal securities laws. RESTRICTIONS ON AGREEMENTS OR UNDERSTANDINGS REGARDING TRANSFER OF COMMON STOCK TO BE PURCHASED IN THE OFFERING Prior to the completion of the Offering, no depositor may transfer or enter into an agreement or understanding to transfer the legal or beneficial ownership of the shares of common stock to be purchased by such person in the Offering. Each depositor and borrower who submits an Order Form will be required to certify that the purchase of common stock by such person is solely for the purchaser's own account and there is no agreement or understanding regarding the sale or transfer of such shares. The Bank intends to pursue any and all legal and equitable remedies in the event it becomes aware of any such agreement or understanding, and will not honor orders reasonably believed by the Bank to involve such an agreement or understanding. 36 PROCEDURE FOR PURCHASING SHARES To ensure that each purchaser receives a Prospectus at least 48 hours before the Expiration Date, Prospectuses may not be mailed any later than five days prior to such date or be hand delivered any later than two days prior to such date. Order forms may only be distributed with a Prospectus. Expiration Date. The Offering will terminate at 12:00 noon, local time on February __, 1998, unless extended by the Bank for up to an additional 45 days or, if approved by the OTS, for an additional period after such 45-day extension (as so extended, the "Expiration Date"). The Bank is not required to give purchasers notice of any extension unless the Expiration Date is later than __________, 1998, in which event purchasers will be given the right to increase, decrease, confirm, or rescind their orders. If the minimum number of shares offered in the Offering (1,358,300 shares) is not sold by the Expiration Date, the Bank may terminate the Offering and promptly refund all orders for common stock. A reduction in the number of shares below the minimum of the Estimated Valuation Range will not require the approval of depositors or an amendment to the Independent Valuation. If the number of shares is reduced below the minimum of the Estimated Valuation Range, purchasers will be given an opportunity to increase, decrease, or rescind their orders. Use of Order Forms. In order to purchase the common stock, each purchaser must complete an Order Form except for certain persons purchasing in the Syndicated Community Offering as more fully described below. Any person receiving an Order Form who desires to purchase common stock may do so by delivering (by mail or in person) to the Bank a properly executed and completed Order Form, together with full payment for the shares purchased. The Order Form must be received prior to 12:00 noon, local time on February __, 1998. ONCE TENDERED, AN ORDER FORM CANNOT BE MODIFIED OR REVOKED WITHOUT THE CONSENT OF THE BANK. Each person ordering shares is required to represent that they are purchasing such shares for their own account. The interpretation by the Bank of the terms and conditions of the Plan and of the acceptability of the Order Forms will be final. The Bank is not required to accept copies of Order Forms. Order Forms cannot and will not be accepted without the execution of the certification appearing on the reverse side of the Order Form. Neither the Bank, the Stock Company, nor Trident Securities is obligated to deliver a Prospectus and an Order Form by any means other than the U.S. Postal Service. 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 (i) check or money order, or (ii) authorization of withdrawal from passbook accounts or certificates of deposit maintained with the Bank. Appropriate means by which such withdrawals may be authorized are provided in the Order Forms. Once such a withdrawal amount has been authorized, a hold will be placed on such funds, making them unavailable to the depositor until the Offering has been completed or terminated. In the case of payments authorized to be made through withdrawal from deposit accounts, all funds authorized for withdrawal will continue to earn interest at the contract rate until the Offering is completed or terminated. Interest penalties for early withdrawal applicable to certificate accounts will not apply to withdrawals authorized for the purchase of shares; however, if a withdrawal results in a certificate account with a balance less than 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 subsequent to the withdrawal. In the case of payments made by check or money order, such funds will be placed in a segregated savings account and interest will be paid by the Bank at the Bank's passbook rate, from the date payment is received until the Offering is completed or terminated. Such interest will be paid by check, on all funds held, including funds accepted as payment for shares of common stock, promptly upon completion or termination of the Offering. An executed Order Form, once received by the Bank, may not be modified, amended or rescinded without the consent of the Bank, unless the Offering is not completed by __________, 1998, in which event purchasers may be given the opportunity to increase, decrease, confirm or rescind their orders for a specified period of time. Owners of self-directed IRAs may use the assets of such IRAs to purchase shares of common stock in the Offering. Individuals who are participants in self-directed tax qualified plans maintained by self-employed individuals ("Keogh Plans") may use the assets in their self-directed Keogh Plan accounts to purchase shares of common stock 37 in the Offering. In addition, the provisions of ERISA and IRS regulations require that executive officers, directors, and 10% stockholders who use self-directed IRA funds and/or Keogh Plan accounts to purchase shares of common stock in the Offering, make such purchase for the exclusive benefit of the IRA and/or Keogh Plan participant. If the ESOP purchases shares of the common stock, such plan will not be required to pay for such shares until consummation of the Offering, provided that there is in force from the time the order is received a loan commitment to lend to the ESOP the amount of funds necessary to purchase the number of shares ordered. Delivery of Stock Certificates. Certificates representing common stock issued in the Offering will be mailed by the Bank to the persons entitled thereto at the registration address noted on the Order Form, as soon as practicable following consummation of the Offering. Any certificates returned as undeliverable will be held by the Bank 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. Subscribers are at their own risk if they sell shares before receiving the certificates or determining whether their subscription has been accepted. PLAN OF DISTRIBUTION AND SELLING COMMISSIONS Offering materials for the Offering initially have been distributed to certain persons by mail, with additional copies made available at the Bank's offices and by Trident Securities. All prospective purchasers are to send payment directly to the Bank, where such funds will be held in a segregated special escrow account and not released until the Offering is completed or terminated. To assist in the marketing of the common stock, the Bank has retained Trident Securities, a broker-dealer registered with the NASD. Trident Securities will assist the Bank in the Offering as follows: (i) in training and educating the Bank's employees regarding the mechanics and regulatory requirements of the Offering; (ii) in conducting informational meetings for employees, customers and the general public; (iii) in coordinating the selling efforts in the Bank's local communities; and (iv) in soliciting orders for common stock. For these services, Trident Securities will receive an advisory and a management fee of 2% of the dollar amount of the common stock sold in the Offering, excluding shares sold to the Bank's directors, officers, employees and employee benefit plans. The Bank also will reimburse Trident Securities for its reasonable out-of-pocket expenses (including legal fees and expenses up to a maximum of $27,500) associated with its marketing effort. The Bank has made an advance payment to Trident Securities in the amount of $7,500. The Bank will indemnify Trident Securities 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 material for the common stock, including liabilities under the Securities Act of 1933. Directors and executive officers of the Bank may participate in the solicitation of offers to purchase common stock. Other trained employees of the Bank may participate in the Offering in ministerial capacities, providing clerical work in effecting a sales transaction or answering questions of a ministerial nature. Other questions of prospective purchasers will be directed to executive officers or registered representatives. The Bank will rely on Rule 3a4-1 of the Exchange Act, so as to permit officers, directors, and employees to participate in the sale of the common stock. No officer, director, or employee of the Bank will be compensated for his participation by the payment of commissions or other remuneration based either directly or indirectly on the transactions in the common stock. A Stock Information Center will be established at the Bank's main office, in an area separated from the Bank's banking operations. Employees will inform prospective purchasers to direct their questions to the Stock Information Center and will provide such persons with the telephone number of the Center. 38 Other Restrictions. Notwithstanding any other provision of the Plan, no person is entitled to purchase any common stock to the extent such purchase would be illegal under any federal or state law or regulation (including state "blue-sky" laws and regulations), or would violate regulations or policies of the NASD, particularly those regarding free riding and withholding. The Bank and/or its agents may ask for an acceptable legal opinion from any purchaser as to the legality of such purchase and may refuse to honor any such purchase order if such opinion is not timely furnished. The Plan prohibits the Bank from lending funds or extending credit to any persons to purchase common stock in the Offering. LIMITATIONS UPON PURCHASES OF COMMON STOCK The following additional limitations have been imposed upon purchases of shares of common stock. Defined terms used in this section and not otherwise defined in this Prospectus shall have the meaning set forth in the Plan. In all cases, the Bank shall have the right, in its sole discretion, to determine whether prospective purchasers are "Associates," or "Acting in Concert" as defined by the Plan and in interpreting any and all other provisions of the Plan. All such determinations are in the sole discretion of the Bank, and may be based on whatever evidence the Bank chooses to use in making any such determination. 1. The aggregate amount of outstanding common stock of the Stock Company owned or controlled by persons other than Mutual Company at the close of the Offering shall not exceed 47% of the Stock Company's total outstanding common stock. 2. No Person or group of persons Acting in Concert, may purchase more than $250,000 of common stock issued in the Offering to Persons other than the Mutual Company, except that: (i) the Stock Company may, in its sole discretion and without further notice to or solicitation of subscribers or other prospective purchasers, increase such maximum purchase limitation to up to 5% or decrease it to 1% of the number of shares issued in the Offering; (ii) Tax-Qualified Employee Plans may purchase up to 10% of the shares issued in the Offering; and (iii) for purposes of this paragraph shares to be held by any Tax-Qualified Employee Plan and attributable to a person shall not be aggregated with other shares purchased directly by or otherwise attributable to such person. 3. The aggregate amount of common stock acquired in the Offering by all Management Persons and their Associates, exclusive of any stock acquired by such persons in the secondary market, shall not exceed 25% of the outstanding shares of common stock of the Stock Company held by persons other than the Mutual Company at the close of the Offering. In calculating the number of shares held by Management Persons and their Associates under this paragraph or under the provisions of paragraph 4 below, shares held by any Tax-Qualified Employee Benefit Plan or any Non-Tax- Qualified Employee Benefit Plan of the Bank that are attributable to such persons shall not be counted. 4. The aggregate amount of common stock acquired in the Offering by all Management Persons and their Associates, exclusive of any common stock acquired by such persons in the secondary market, shall not exceed 25% of the stockholders' equity of the Bank. In calculating the number of shares held by Management Persons and their Associates under this paragraph or under the provisions of paragraph C of this section, shares held by any Tax-Qualified Employee Benefit Plan or any Non- Tax-Qualified Employee Benefit Plan of the Bank that are attributable to such persons shall not be counted. 5. The Boards of Directors of the Bank and the Stock Company may, in their sole discretion, increase the maximum purchase limitation to up to 9.9%, provided that orders for common stock in excess of 5% of the number of shares of common stock issued in the Offering shall not in the aggregate exceed 10% of the total shares of common stock issued in the Offering (except that this limitation 39 shall not apply to purchases by Tax-Qualified Employee Plans). If such 5% limitation is increased, subscribers for the maximum amount will be, and certain other large subscribers in the sole discretion of the Stock Company and the Bank may be, given the opportunity to increase their subscriptions up to the then applicable limit. Requests to purchase additional shares of common stock under this provision will be determined by the Board of Directors of the Stock Company, in its sole discretion. 6. In the event of an increase in the total number of shares offered in the Subscription Offering due to an increase in the maximum of the Estimated Valuation Range of up to 15% (the "Adjusted Maximum"), the additional shares will be issued 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 oversubscription at the Eligible Account Holder, Supplemental Eligible Account Holder, or employee, officer and director categories, to fill unfulfilled subscriptions of such subscribers according to their respective priorities set forth in the Plan. 7. Notwithstanding any other provision of the Plan, no person shall be entitled to purchase any common stock to the extent such purchase would be illegal under any federal law or state law or regulation or would violate regulations or policies of the National Association of Securities Dealers, Inc., particularly those regarding free riding and withholding. The Stock Company and/or its agents may ask for an acceptable legal opinion from any purchaser as to the legality of such purchase and may refuse to honor any purchase order if such opinion is not timely furnished. 8. The Board of Directors of the Stock Company has the right in its sole discretion to reject any order submitted by a person whose representations the Board of Directors believes to be false or who it otherwise believes, either alone or acting in concert with others, is violating, circumventing, or intends to violate, evade or circumvent the terms and conditions of the Plan. The Stock Company, in its sole discretion, may make reasonable efforts to comply with the securities laws of any state in the United States in which its depositors reside, and will only offer and sell the common stock in states in which the offers and sales comply with such states' securities laws. However, no person will be offered or allowed to purchase any common stock under the Plan if they resides in a foreign country or in a state of the United States with respect to which any of the following apply: (i) a small number of persons otherwise eligible to purchase shares under the Plan reside in such state or foreign county; (ii) the offer or sale of shares of common stock to such persons would require the Bank or its employees to register, under the securities laws of such state or foreign country, as a broker or dealer or to register or otherwise qualify its securities for sale in such state or foreign country; or (iii) such registration or qualification would be impracticable for reasons of cost or otherwise. OTS regulations define "acting in concert" as (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. THE BANK WILL PRESUME THAT CERTAIN PERSONS ARE ACTING IN CONCERT BASED UPON VARIOUS FACTS, INCLUDING THE FACT THAT PERSONS HAVE JOINT ACCOUNT RELATIONSHIPS OR THE FACT THAT SUCH PERSONS HAVE FILED JOINT SCHEDULES 13D WITH THE SEC WITH RESPECT TO OTHER COMPANIES. Directors are not treated as Associates of one another solely because of their board membership. Compliance with the foregoing limitations does not necessarily constitute compliance with other regulatory restrictions on acquisitions of the common stock. For a further discussion of limitations on purchases of the common stock during and subsequent to Reorganization, see "--Restrictions on Sale of Stock by Directors and Officers," "--Restrictions on Purchase of Stock by Directors and Officers Following Reorganization," and "Restrictions on Acquisition of the Stock Company." 40 RESTRICTIONS ON REPURCHASE OF STOCK BY THE STOCK COMPANY OTS regulations and policy currently prohibit the Stock Company from repurchasing any of its shares within three years following the Reorganization unless the repurchase is (i) part of a general repurchase made on a pro rata basis pursuant to an offer approved by the OTS and made to all stockholders (except the Mutual Company may be excluded from the repurchase with OTS approval), (ii) limited to the repurchase of qualifying shares of a director, or (iii) in open market transaction by a tax-qualified or non-tax qualified employee benefit plan in an amount reasonable and appropriate to fund such plan. RESTRICTIONS ON SALE OF STOCK BY DIRECTORS AND OFFICERS All shares of the common stock purchased by directors and officers of the Bank or the Stock Company in the Offering will be subject to the restriction that such shares may not be sold or otherwise disposed of for value for a period of one year following the date of purchase, except for any disposition of such shares (i) following the death of the original purchaser or (ii) by reason of an exchange of securities in connection with a merger or acquisition approved by the applicable regulatory authorities. Sales of shares of the common stock by the Stock Company's directors and officers will also be subject to certain insider trading and other transfer restrictions under the federal securities laws. See "Regulation--Federal Securities Laws" and "Description of Capital Stock." Each certificate for such restricted shares will bear a legend prominently stamped on its face giving notice of the restrictions on transfer, and instructions will be issued to the Stock Company's transfer agent to the effect that any transfer within such time period of any certificate or record ownership of such shares other than as provided above is a violation of the restriction. Any shares of common stock issued pursuant to a stock dividend, stock split or otherwise with respect to restricted shares will be subject to the same restrictions on sale. RESTRICTIONS ON PURCHASE OF STOCK BY DIRECTORS AND OFFICERS IN THE REORGANIZATION AND OFFERING OTS regulations provide that for a period of three years following the Reorganization, without prior written approval of the OTS, neither directors nor officers of the Bank or the Stock Company nor their associates may purchase shares of the common stock of the Stock Company, except from a dealer registered with the SEC. This restriction does not, however, apply to negotiated transactions involving more than 1% of the Stock Company's outstanding common stock, to shares purchased pursuant to stock option or other incentive stock plans approved by the Stock Company's shareholders, or to shares purchased by employee benefit plans maintained by the Stock Company which may be attributable to individual officers or directors. RESTRICTIONS ON TRANSFER OF SUBSCRIPTION RIGHTS AND COMMON STOCK Prior to the completion of the Reorganization, OTS regulations and the Plan prohibit any person with subscription rights from transferring or entering into any agreement or understanding to transfer the legal or beneficial ownership of the subscription rights issued under the Plan or the shares of common stock to be issued upon their exercise. Such rights may be exercised only by the person to whom they are granted and only for his or her account. Each person exercising such 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 such subscription rights or shares of common stock prior to the completion of the Reorganization and Offering. THE BANK INTENDS TO PURSUE ANY AND ALL LEGAL AND EQUITABLE REMEDIES IN THE EVENT IT BECOMES AWARE OF THE TRANSFER OF SUBSCRIPTION RIGHTS AND WILL NOT HONOR ORDERS KNOWN TO INVOLVE THE TRANSFER OF SUCH RIGHTS. IN ADDITION, PERSONS WHO VIOLATE THE PURCHASE LIMITATIONS MAY BE SUBJECT TO SANCTIONS AND PENALTIES IMPOSED BY THE OTS. 41 FEDERAL AND STATE TAX CONSEQUENCES OF THE REORGANIZATION The Bank intends to proceed with the Reorganization on the basis of an opinion from its special counsel, Luse Lehman Gorman Pomerenk & Schick, P.C., Washington, D.C., as to certain tax matters that are material to the Reorganization. The opinion is based, among other things, on certain representations made by the Bank, including the representation that the exercise price of the subscription rights to purchase the common stock will be approximately equal to the fair market value of the stock at the time of the completion of the Reorganization. With respect to the subscription rights, the Bank has received an opinion of Feldman Financial which, based on certain assumptions, concludes that the subscription rights to be received by Eligible Account Holders, Supplemental Eligible Account Holders and Other Members do not have any economic value at the time of distribution or the time the subscription rights are exercised, whether or not a Community Offering takes place, and Luse Lehman Gorman Pomerenk & Schick, P.C.'s opinion is given in reliance thereon. The Opinion of Luse Lehman Gorman Pomerenk & Schick, P.C., provides substantially as follows: 1. The change in form from a mutual savings Bank ("Mutual Bank") to a stock savings Bank (the "Stock Bank") will qualify as a reorganization under Section 368(a)(1)(F) of the Internal Revenue Code, as amended ("Code"), and no gain or loss will be recognized to the Bank in either its mutual form or stock form by reason of the Reorganization. 2. No gain or loss will be recognized by the Mutual Bank upon the transfer of the Mutual Bank's assets to the Stock Bank solely in exchange for shares of Stock Bank stock and the assumption by the Stock Bank of the liabilities of the Mutual Bank. 3. No gain or loss will be recognized by Stock Bank upon the receipt of the assets of the Mutual Bank in exchange for shares of Stock Bank common stock. 4. Stock Bank's holding period in the assets received from the Mutual Bank will include the period during which such assets were held by the Mutual Bank. 5. Stock Bank's basis in the assets of the Mutual Bank will be the same as the basis of such assets in the hands of the Mutual Bank immediately prior to the proposed transaction. 6. The Mutual Bank members will recognize no gain or loss upon the constructive receipt of Stock Bank common stock solely in exchange for their membership interests in the Mutual Bank. 7. The Stock Bank will succeed to and take into account the Mutual Bank earnings and profits or deficit in earnings and profits, as of the date of the Reorganization. 8. The exchange of stock by the Stock Bank stockholders (formerly, the Mutual Bank's members) in exchange for membership interests in the Mutual Company will constitute a tax-free exchange of property solely for voting "stock" pursuant to Section 351 of the Internal Revenue Code. 9. The Stock Bank's stockholders will recognize no gain or loss upon the transfer of the Stock Bank stock they constructively received to the Mutual Company solely in exchange for membership interests in the Mutual Company. 10. The Mutual Company will recognize no gain or loss upon the receipt of property from the Stock Bank stockholders in exchange for membership interests in the Mutual Company. 42 11. The Mutual Company's basis in the property received from the Stock Bank stockholders will be the same as the basis of such property in the hands of Stock Bank stockholders immediately prior to the transaction. 12. The Mutual Company's holding period for the property received from Stock Bank's stockholders will include the period during which such property was held by Stock Bank stockholders. 13. The Stock Bank depositors will recognize no gain or loss solely by reason of the transaction. 14. The Mutual Company and the Minority Stockholders will recognize no gain or loss upon the transfer of Stock Bank stock and cash, respectively, to the Stock Company in exchange for Common Stock of the Stock Company. 15. The Stock Company will recognize no gain or loss upon its receipt of property from the Mutual Company and Minority Stockholders in exchange for Common Stock of the Stock Company. 16. The basis of the Stock Company common stock to the Minority Stockholders will be the actual purchase price ($10.00) thereof, and a shareholders holding period for Common Stock acquired through the exercise of subscription rights will begin on the date the rights are exercised. The opinions of Luse Lehman Gorman Pomerenk & Schick, P.C., unlike a letter ruling issued by the Internal Revenue Service, are not binding on the Service and the conclusions expressed herein may be challenged at a future date. The Service has issued favorable rulings for transactions substantially similar to the proposed Reorganization, but any such ruling may not be cited as precedent by any taxpayer other than the taxpayer to whom the ruling is addressed. The Bank does not plan to apply for a letter ruling concerning the transactions described herein. The Bank has also received an opinion from Cherry, Bekaert & Holland, L.L.P. that implementation of the Plan will not result in any North Carolina income tax liability to the Bank, its account holders, borrowers the Stock Company or the Mutual Company. 43 GASTON FEDERAL SAVINGS AND LOAN ASSOCIATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS The following Consolidated Statements of Operations of the Bank for the fiscal years ended September 30, 1997 and 1996 have been audited by Cherry, Bekaert & Holland, L.L.P., independent certified public accountants, whose report thereon appears elsewhere in this Prospectus. These statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Prospectus.
Fiscal Year Ended September 30, ------------------------------- 1997 1996 -------- ---------- (In Thousands) INTEREST INCOME: Loans............................................................ $ 10,826 $ 10,218 Investment securities............................................ 1,321 1,361 Mortgage-backed and related securities........................... 789 939 ---------- ---------- Total interest income......................................... 12,936 12,518 INTEREST EXPENSE: Deposits......................................................... 6,805 7,293 Borrowed funds................................................... 147 88 ---------- ---------- Total interest expense........................................ 6,952 7,381 ---------- ---------- Net interest income........................................... 5,984 5,137 PROVISION FOR LOAN LOSSES............................................ 293 47 ---------- ---------- Net income after provision for loan losses 5,691 5,090 ---------- ---------- NONINTEREST INCOME: Service charges on deposit accounts.............................. 209 189 Gain on sale of securities....................................... 52 -- Other income..................................................... 255 228 ---------- ---------- Total noninterest income...................................... 516 417 ---------- ---------- NONINTEREST EXPENSES: Salaries and benefits............................................ 2,228 1,976 Occupancy expense................................................ 465 500 Deposit insurance................................................ 139 1,197 Computer expense................................................. 139 164 Advertising...................................................... 220 144 Professional services............................................ 184 175 Other............................................................ 581 490 ---------- ---------- Total noninterest expense..................................... 3,956 4,646 ---------- ---------- Income before income taxes........................................... 2,251 861 Provision for income taxes........................................... 819 351 ---------- ---------- Net income........................................................... $ 1,432 $ 510 ========== ==========
44 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Stock Company has only recently been formed and accordingly, has no results of operations. The Bank's 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 primarily of the interest paid on deposits and borrowings. Results of operations are also affected by the Bank's provision for loan losses, securities sales, and service charges on its deposit accounts. The Bank's non-interest expense primarily consists of salaries and employee benefits, occupancy expense, federal deposit insurance premiums, advertising and other expenses. Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities. OPERATING STRATEGY We have implemented several strategies designed to continue the institution's profitability consistent with safety and soundness. These strategies include: (i) emphasizing one- to four-family residential real estate lending; (ii) growing our portfolio of high-yielding loans in a controlled, safe and sound manner; (iii) maintaining asset quality as we implement our strategies; and (iv) assembling a new management team with substantial banking experience. Emphasizing Traditional One- to Four-Family Residential Real Estate Lending. Historically, the Bank has emphasized one- to four-family residential lending within the Piedmont region of North Carolina. As of September 30, 1997, approximately 76.5% of our total loan portfolio consisted of one- to four-family residential real estate loans. During the fiscal year ended September 30, 1997, we originated $12.6 million of one- to four-family residential real estate loans, and our portfolio of such loans totaled $126.1 million. Although the yields on these type of loans are often less than on other types of loans that we originate, we intend to continue to emphasize this type of lending to complement the strategies described below because our experience has shown these loans to be high quality loans with relatively few delinquencies. Complementing Our Traditional Lending by Growing our Portfolio of High-Yielding Loans. To complement our traditional emphasis on one- to four-family residential real estate lending, we intend to grow our portfolio of higher-yielding loans in a controlled, safe and sound manner. As of September 30, 1997, our portfolio of construction and commercial and multifamily residential real estate loans totaled $19.7 million, our portfolio of commercial business loans totaled $5.6 million, and our portfolio of consumer loans totaled $7.4 million. In the aggregate, $32.7 million, or 23.5%, of our total loan portfolio consisted of these loans. Because the yields on these types of loans are generally higher than the yields on one- to four-family residential real estate loans, our goal over the next several years is to increase our portfolio of these loans in a controlled, safe and sound manner. To accomplish the growth that we desire in this area, we have hired, in addition to the persons identified below, two additional commercial lenders and a branch manager with substantial consumer loan experience. Although our experience has shown that we are able to safely originate these loans, most industry experts believe them to expose lenders to greater risk of loss than one- to four-family residential real estate loans. Maintaining Asset Quality as We Implement Our Lending Strategies. As of September 30, 1997, we had $1.3 million of nonperforming assets, which represented .75% of total assets, and we had $1.1 million of nonperforming loans, which represented .79% of net loans. Our allowance for loan losses as of September 30, 1997 was $1.1 million, or .83% of total loans and 104.8% of nonperforming loans. During the fiscal years ended September 30, 1997 and 1996, we charged-off loans totaling $13,000 and $3,000, respectively. Our goal is to maintain our assets quality and gradually increase our reserves as we increase our portfolio of higher yielding loans. To accomplish this objective we intend to maintain strict underwriting standards. It also may be necessary to increase our provision for loan losses, which will have an adverse effect on our net income. 45 Assembling a New Management Team. To accomplish the objectives described above we have assembled a management team with substantial banking experience, including a new president and chief executive officer, Kim S. Price, and a new chief financial officer, Gary F. Hoskins. Over the past six years, Mr. Price has overseen loan production at a national bank, and has substantial experience in originating both real estate and non-real estate loans, which will complement our traditional experience in real estate lending. The Board of Directors believes that these new officers, along with the current executive officer, Paul L. Teem, Jr. will enable the Bank to implement the strategies established by the Bank. MANAGEMENT OF MARKET RISK Generally. The Bank's most significant form of market risk is interest-rate risk, as the majority of the Bank's assets and liabilities are sensitive to changes in interest rates. The principal objective of the Bank's interest rate risk management is to evaluate the interest rate risk inherent in the Bank's assets and liabilities, determine the level of risk appropriate given the Bank's business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with the guidelines approved by the Board of Directors. Through such management, the Bank seeks to reduce the vulnerability of its operations to changes in interest rates. The Bank's Asset/Liability Committee comprises the Bank's senior management under the direction of the Board of Directors, with senior management responsible for reviewing with the Board of Directors its activities and strategies, the effect of those strategies on the Bank's net interest margin, the fair value of the portfolio and the effect that changes in interest rates will have on the Bank's portfolio and the Bank's exposure limits. See "Risk Factors--Potential Effects of Changes in Interest Rates and the Current Interest Rate Environment." In recent years, the Bank has utilized the following strategies to manage interest rate risk: (1) emphasizing the origination and retention of one- to four-family residential ARM loans and fixed-rate loans with maturities of 15 years or less, (2) emphasizing the origination and retention of commercial and multi-family residential real estate loans and commercial business loans with adjustable interest rates, and (3) emphasizing the origination of home equity lines of credit that have adjustable interest rates and mature in 15 years or less and other consumer loans that mature in five years or less, and (4) investing in shorter term securities which generally bear lower yields as compared to longer term investments, but which better position the Bank for increases in market interest rates. Management recognizes that the long-term effect of interest rate changes on the Bank's income can be substantial. Accordingly, management has increased the attractiveness of its 10 to 15 year mortgage loans with below-market rates. In addition, the Bank aggressively markets shorter term non-mortgage loans and adjustable rate home equity lines of credit. Net Portfolio Value. In recent years, we have measured our interest rate sensitivity by computing the "gap" between the assets and liabilities which were expected to mature or reprice within certain time periods, based on assumptions regarding loan prepayment and deposit decay rates formerly provided by the OTS. However, the OTS now requires the computation of amounts by which the net present value of an institution's cash flow from assets, liabilities and off balance sheet items (the institution's 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 an institution's NPV from instantaneous and permanent 1% to 4% (100 to 400 basis points) increases and decreases in market interest rates. The following table presents our NPV at September 30, 1997, as calculated by the OTS, which is based upon quarterly information that we voluntarily provided to the OTS. 46 Percentage Change in Net Portfolio Value ---------------------------------------- Changes Board in Market Projected Policy Interest Rates Change (1) Limit (2) -------------- ---------- --------- (basis points) + 400 (52.00)% (65.00)% + 300 (38.00)% (45.00)% + 200 (24.00)% (30.00)% + 100 (12.00)% (15.00)% 0 0.00% 0.00% (100) 7.00% (15.00)% (200) 13.00% (30.00)% (300) 16.00% (45.00)% (400) 20.00% (65.00)% - ------------------------- (1) Calculated as the amount of change in the estimated NPV divided by the estimated NPV assuming no change in interest rates. (2) Limits are established by our Board of Directors. Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. Modeling changes in NPV requires 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 the Bank's 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 the Bank's 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 the Bank's net interest income and will differ from actual results. COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 1997 AND 1996 Assets. Total assets for the fiscal year ended September 30, 1997, increased by $1.5 million, or 0.9%, from $172.0 million to $173.5 million. While the increase in total assets was moderate, there were significant changes in the overall asset portfolio mix during the fiscal year. Cash and cash equivalents increased by $2.4 million, or 109.1%, from $2.2 million to $4.6 million. Investments and mortgage-backed securities decreased by $4.5 million, or 13.6%, from $33.2 million to $28.7 million. Also, total loans increased by $3.6 million, or 2.8%, from $130.9 million to $134.5 million. This change in asset mix was due, in part, to the declining interest rate environment which resulted in higher loan demand, increased prepayments on mortgage-backed securities, and increased calls on U.S. Government Agency callable securities. Total assets will increase as a result of the Offering. See "Use of Proceeds" for a discussion of the manner in which the Stock Company intends to use the proceeds of the Offering. Liabilities. Total liabilities for the fiscal year ended September 30, 1997, decreased by $300,000, or 2.0%, from $152.9 million to $152.6 million. This slight decrease was primarily due to a $600,000 decrease in deposits from $146.0 million to $145.4 million which resulted, in part, from the increased competition in the Bank's local market area. Also during the period, Federal Home Loan Bank advances decreased by $250,000 to $3.5 million. Total Equity. Total equity for the fiscal year ended September 30, 1997, increased by $1.9 million, or 8.2%, from $19.1 million to $20.9 million. The increase in total equity was due to the transfer of $1.4 million in net income to retained earnings and a $400,000 increase in the unrealized gain on securities held as available for sale. The Offering will result in an increase in the Stock Company's equity (as compared to the Bank's equity prior to the 47 Offering) in an amount equal to net Offering proceeds minus (i) the $100,000 used to capitalize the Mutual Company and (ii) the cost of the shares purchased by the ESOP. ANALYSIS OF RESULTS OF OPERATIONS 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 the Bank at September 30, 1997 and for the years ended September 30, 1997 and 1996. 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. All average balances are monthly averages.
For the Years Ended September 30, ---------------------------------------------------------------- At September 30, 1997 1997 1996 --------------------- ------------------------------- ------------------------------- 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: Loans receivable (1) $134,491 8.05% $132,529 $10,826 8.17% $126,503 $10,218 8.08% Investment securities (2) 18,655 6.60 18,226 1,232 6.76 18,501 1,265 6.84 Interest-earning deposits 2,203 4.04 1,049 89 8.48 1,817 96 5.28 Mortgage-backed securities 10,087 7.82 11,612 789 6.79 13,528 939 6.94 -------- ---- -------- ------- ------ -------- ------- ------ Total interest-earning assets 165,436 7.82 163,416 12,936 7.92 160,349 12,518 7.81 Non-interest-earning assets 8,034 7,751 9,144 -------- -------- -------- Total assets $173,470 $171,167 $169,493 ======== ======== ======== Interest-bearing liabilities: Demand deposits and money market demand accounts $28,929 2.32 $27,201 672 2.47 $25,773 685 2.66 Passbook savings 14,197 2.73 14,037 387 2.76 13,695 394 2.88 Certificate of deposit 102,318 5.62 105,119 5,746 5.47 107,196 6,215 5.80 Borrowed funds 3,500 4.20 2,309 147 6.37 1,403 88 6.27 -------- ---- -------- ------- ------ -------- ------- ------ Total interest-bearing liabilities 148,944 4.67% 148,666 6,952 4.68% 148,067 7,382 4.99 ==== ------- ====== ------- ------ Non-interest-bearing liabilities 3,658 3,098 2,912 -------- -------- Total liabilities 152,602 151,764 150,979 Total equity 20,868 19,403 18,514 -------- -------- -------- Total liabilities and retained earnings $173,470 $171,167 $169,493 ======== ======== ======== Net interest income $ 5,984 $ 5,136 ======= ======= Interest rate spread (2) 3.24% 2.82% ====== ====== Net yield on interest-earning assets (3) 3.66% 3.20% ====== ====== Ratio of average interest-earning assets to interest-bearing liabilities 109.92% 108.29% ====== ======
- -------------------------- (1) Average balances include nonaccrual loans. (2) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (3) Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets. 48 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 Year Ended September 30, 1996 vs September 30, 1997 Increase (Decrease) Due to --------------------------------------------- Rate/ Volume Rate Volume Total ------ ---- ------ ----- (Dollars in thousands) Interest Income: Securities and other interest earning assets $ (69) $ 31 $(2) $ (40) Mortgage-backed and related securities (133) (20) 3 (150) Loan portfolio.................................... 486 116 6 608 ------ ------ ------ ------- Total interest-income......................... 284 127 7 418 ------ ------ ------ ------- Interest expense: Deposits.......................................... (16) (474) 1 (489) Borrowed funds.................................... 57 1 1 59 ------ ------ ------ ------- Total interest-expense........................ 41 (473) 2 (430) ------ ------ ------ ------- Net interest income.................................... $ 243 $ 600 $ 5 $ 848 ====== ====== ====== =======
COMPARISON OF OPERATING RESULTS FOR THE FISCAL YEARS ENDED SEPTEMBER 30, 1997 AND 1996 General. The earnings of the Bank depend primarily on its level of net interest income, which is the difference between interest earned on the Bank's interest-earning assets, consisting primarily of real estate loans, commercial business loans, consumer loans, investment securities and mortgage-backed securities, and the interest paid on interest-bearing liabilities, consisting primarily of deposits and borrowed funds. Net interest income is a function of the Bank's interest rate spread, which is the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities, as well as a function of the average balance of interest-earning assets as compared to interest-bearing liabilities. The Bank's earnings also are affected by its level of service charges and gains on sale of assets, as well as its level of non-interest expenses, including salaries and benefits, occupancy, deposit insurance, advertising, professional services and other non-interest expenses. Management intends to initially invest the Offering proceeds in interest earning assets and believes that the Bank and the Stock Company will derive additional interest income from such sources. However, there can be no assurances that the overall amount of earnings of the Stock Company will be higher than the historical earnings of the Bank as a result of the Offering. See "Use of Proceeds." Net Income. Net income for the fiscal year ended September 30, 1997 increased by $922,000, to $1.4 million for the fiscal year ended September 30, 1997 from $510,000 for the prior fiscal year. The increase was primarily due to an $847,000 increase in net interest income, a $690,000 decrease in noninterest expenses (primarily do to a special assessment to recapitalize the SAIF as discussed below in "--Noninterest Expenses"), and a $99,000 increase in noninterest income. The effects of these increases were partially offset by a $246,000 increase in the provision for loan losses and a $468,000 increase in the provision for income taxes. These changes are discussed below. 49 Interest Income. Interest income increased by $418,000, or 3.3%, to $12.9 million for the fiscal year ended September 30, 1997 from $12.5 million for the prior fiscal year. The increase was due to a $608,000 increase in income from loans, the effects of which were partially offset by a $40,000 decrease in income from investment securities, a slight decrease in income from interest-earning deposits, and a $150,000 decrease in income from mortgage-backed securities. The increase in income from loans was attributable to a $6.0 million, or 4.8%, increase in the average balance of loans to $132.5 million from $126.5 million and an 9 basis point increase in the average yield on loans to 8.17% from 8.08%. The increase in the Bank's average loan portfolio was attributable to $21.9 million of loan originations resulting in increases in the Bank's portfolio of one- to four-family residential and commercial real estate loans, commercial business loans and home equity lines of credit. The Bank's strategy is to continue to prudently grow its loan portfolio, although there can be no assurances that the Bank will be able to do so. The increase in yield on loans receivable resulted, in part, from a change in the composition of the Bank's loan portfolio from lower yielding residential mortgage loans to higher yielding commercial loans and nonmortgage loans. During the fiscal year, commercial mortgage loans increased from $6.5 million to $7.3 million, or from 4.8% to 5.3% of the Bank's total loan portfolio. Also, nonmortgage loans increased from $11.6 million to $13.0 million, or from 8.5% to 9.3% of the Bank's total loan portfolio. The yield also increased due to repricing of teaser rate ARMs which were originated during the fiscal year ended September 30, 1996. Interest income from the Bank's investment securities decreased by $40,000, or 2.9%, to $1.32 million from approximately $1.36 million. The decrease in interest income from investment securities resulted from a $275,000 decrease in average investment securities to $18.2 million from $18.5 million, and an 8 basis point decrease in the yield on average investment securities to 6.76% from 6.84%. Interest income on mortgage-backed securities decreased by $150,000, or 16.0%, to $789,000 from $939,000. The decrease in income from mortgage-backed securities resulted from a $1.9 million, or 14.1% decrease in average mortgage-backed securities to $11.6 million from $13.5 million, and a 15 basis point decrease in the yield on average mortgage-backed securities to 6.79% from 6.94%. In addition, income from interest-earning deposits decreased slightly. The changes in average balances of the Bank's investment securities and mortgage-backed securities resulted from an increase in calls on U.S. Government Agency callable securities and an increase in prepayments on mortgage-backed securities due to an overall decrease in interest rates during the fiscal year. This decrease in market interest rates also resulted in an 8 basis point decrease in the average yield on the Bank's investment securities and mortgage-backed securities portfolio. Interest Expense. Interest expense decreased by $429,000, or 5.8%, to $7.0 million for the fiscal year ended September 30, 1997 from $7.4 million for the prior fiscal year. This decrease was the result of a decrease in the Bank's average cost of funds, the effects of which were partially offset by a slight increase in the Bank's average interest bearing liabilities. The increase in average interest-bearing liabilities resulted from increases in the average balances of demand deposits and money market demand accounts, passbook savings and borrowed funds, partially offset by a decrease in the Bank's certificates of deposit. The decrease in the average cost of the Bank's interest-bearing liabilities resulted from an overall decrease in market interest rates during the fiscal year and a change in the portfolio mix of the Bank's deposits. From September 30, 1996 to September 30, 1997, higher-costing certificates of deposit decreased from $106.1 million to $102.3 million, or from 72.7% to 70.3% of the Bank's total deposit portfolio, respectively. This was offset by a corresponding increase in lower-costing NOW accounts and passbook savings accounts which increased from $39.9 million to $43.1 million, or from 27.3% to 29.7% of the Bank's total deposits. Provision for Loan Losses. The Bank establishes provisions for loan losses, which are charged to operations, in order to maintain the allowance for loan losses at a level which is deemed appropriate to absorb future charge-offs of loans deemed uncollectible. In determining the appropriate level of the allowance for loan losses, management considers past and anticipated loss experience, evaluations of real estate collateral, current and anticipated economic conditions, volume and type of lending and the levels of nonperforming and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates. Management of the Bank assesses the allowance for loan losses on a quarterly basis and makes provisions for loan losses monthly in order to maintain the adequacy of the allowance. 50 The Bank provided $293,000 and $47,000 in loan loss provisions during the fiscal years ended September 30, 1997 and 1996, respectively. The increase was primarily due to the growth in our portfolio of higher-yielding construction, commercial and multifamily residential real estate, and commercial business loans. Based on our own experience, and industry experience, we believe that these types of loans expose our operations to greater risk of loss than the one- to four-family residential real estate loans that we have traditionally emphasized. At September 30, 1997 and 1996 the Bank's allowance for loan losses was $1.1 million and $830,000, respectively, and the Bank's nonperforming loans were $1.1 million and $1.2 million, respectively. The Bank's allowance for loan losses as a percentage of total nonperforming loans at September 30, 1997 and 1996 was 104.8% at and 69.5%, respectively. While management uses available information to recognize losses on loans, future loan loss provisions may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses and may require the Bank to recognize additional provisions based on their judgment of information available to them at the time of their examination. See "Risk Factors--Lending Risks Associated With Commercial Real Estate, Multi-Family and Consumer Lending" and "Business of the Bank--Nonperforming Assets and Delinquencies" and "--Allowance for Loan Losses". Noninterest Income. Noninterest income is composed of service charges on deposit accounts, gain on sale of securities and other income. Noninterest income increased by $99,000, or 23.7%, to $516,000 for the fiscal year ended September 30, 1997 from $417,000 for the prior fiscal year, as service charges on deposit accounts increased by $20,000, gain on sale of securities increased by $52,000, and other income increased by $27,000. Management's goal is to continue to increase the Bank's noninterest income by increasing the balance of the Bank's demand deposit accounts and the associated service charges, although there can be no assurances that the Bank will be successful in this strategy. In addition, management has recently adjusted its fee structure in its mortgage loan area with the goal of improving noninterest income. Noninterest Expenses. Noninterest expenses decreased by $688,000, or 14.8%, to $4.0 million for the fiscal year ended September 30, 1997 from $4.6 million for the prior fiscal year. The decrease was primarily due to a $1.1 million decrease in deposit insurance as a result of legislation, enacted in September 1996, to recapitalize the Savings Association Insurance Fund (the "SAIF") by a one-time assessment on all SAIF-insured deposits held as of March 31, 1995. The effect of the decrease in deposit insurance was partially offset by a $252,000, or 12.8%, increase in salaries and benefits to $2.2 million for the fiscal year ended September 30, 1997 from $2.0 million for the prior fiscal year. The SAIF assessment was 65.7 basis points per $100 in deposits, payable on November 30, 1996. For the Bank, the assessment amounted to $867,000 (or approximately $552,000 when adjusted for taxes), based on the Bank's SAIF-insured deposits as of March 31, 1995. In addition, beginning January 1, 1997, pursuant to the legislation, interest payments on FICO bonds issued in the late 1980's by the Financing Corporation to recapitalize the former Federal Savings and Loan Insurance Corporation will be paid jointly by institutions insured by the Bank Insurance Fund (the "BIF") and SAIF-insured institutions. The FICO assessment will be 1.29 basis points per $100 in BIF deposits and 6.44 basis points per $100 in SAIF deposits. Beginning January 1, 2000, the FICO interest payments will be paid pro-rata by banks and thrifts based on deposits (approximately 2.4 basis points per $100 in deposits). The BIF and SAIF will be merged on January 1, 1999, provided the bank and saving association charters are merged by that date. In that event, pro-rata FICO sharing will begin on January 1, 1999. Management believes that noninterest expenses are likely to increase following the Reorganization and Offering due to the expenses of being a public company. These expenses include costs of preparing financial reports and public documents, and increased costs associated with communicating with stockholders and investors. In addition, salaries and benefits expenses are likely to increase due to the ESOP, and the Recognition Plan that the Bank intends to implement no earlier than six months after the conclusion of the Reorganization. Generally accepted accounting principles require the Stock Company to record compensation expense upon the vesting of shares of restricted stock awarded pursuant to the Recognition Plan and upon the commitment to release shares under the ESOP. In addition, generally accepted accounting principles will require the Stock Company to record compensation expense in an amount equal to the fair value of the shares committed to be released to employees from the ESOP. Accordingly, future increases and decreases in fair value of common stock committed to be released will have a 51 corresponding effect on compensation expense related to the ESOP. To the extent that the fair value of the Bank's ESOP shares differ from the cost of such shares, the differential will be charged or credited to equity. Provision for Income Taxes. The Bank's provision for income taxes was $819,000 and $351,000 for the fiscal years ended September 30, 1997 and 1996. The higher provision for the fiscal year ended September 30, 1997 related primarily to an increase in income before income taxes. The Bank's effective tax rate decreased to 36.4% for the fiscal year ended September 30, 1997 from 40.8% for the fiscal year ended September 30, 1996 primarily due to the effects of certain non-deductible expenses incurred in 1996. CAPITAL RESOURCES AND LIQUIDITY The Bank's 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. The Bank's primary sources of internally generated funds are principal and interest payments on loans receivable, cash flows generated from operation, and cash flows generated by investments. External sources of funds include increases in deposits and advances from the FHLB of Atlanta. Management believes that the Bank's liquidity will be initially increased due to the proceeds received from the Offering. The Bank is required under applicable federal regulations to maintain specified levels of "liquid" investments in qualifying types of United States Government, federal agency and other investments having maturities of five years of less. Current OTS regulations require that a savings association maintain liquid assets of not less than 4% of its average daily balance of net withdrawable deposit accounts and borrowings payable in one year or less. Monetary penalties may be imposed for failure to meet applicable liquidity requirements. At September 30, 1997, the Bank's liquidity, as measured for regulatory purposes, was in excess of the minimum OTS requirement. At September 30, 1997, the Bank had loan commitments (excluding undisbursed portions of interim construction loans of $3.0 million) of $2.0 million and unused lines of credit of $9.5 million. The Bank believes that it has adequate resources to fund loan commitments as they arise. If the Bank requires funds beyond its internal funding capabilities, additional advances from the FHLB of Atlanta are available. At September 30, 1997, approximately $87.7 million of time deposits scheduled to mature within a year, and the Bank expects that a portion of these time deposits will not be renewed upon maturity. Following the conversion, the Stock Company will initially conduct no business other than holding the capital stock of the Bank and the loan it will make to the ESOP. In order to provide sufficient funds for its operations, the Stock Company expects to retain and invest 50% of the net proceeds of the offering remaining after making the loan to the ESOP. In the future, the Stock Company's primary source of funds, other than income from its investments and principal and interest payments received with respect to the ESOP loan, is expected to be dividends from the Bank. As a stock savings bank, the Bank may not declare or pay a cash dividend on its capital stock if the effect of such transaction would be to reduce the net worth of the institution to an amount which is less than the minimum amount required by applicable federal regulations. At September 30, 1997, the Bank complied with all applicable capital requirements. IMPACT OF INFLATION AND CHANGING PRICES The Consolidated Financial Statements and related Notes have been prepared in accordance with generally accepted accounting principles, which generally 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. The impact of inflation is reflected in the increased cost of the Bank's operations. Nearly all the assets and liabilities of the Bank are financial, unlike most industrial companies. As a result, the Bank's performance is 52 directly impacted by changes in interest rates, which are indirectly influenced by inflationary expectations. The Bank's ability to match the interest sensitivity of its financial assets to the interest sensitivity of it financial liabilities in its asset/liability management may tend to minimize the effect of changes in interest rates on the Bank's performance. Changes in interest rates do not necessarily move to the same extent as changes in the price of goods and services. In the current interest rate environment, liquidity and the maturity structure of the Bank's assets and liabilities are critical to the maintenance of acceptable performance levels. CAPABILITY OF THE BANK'S DATA PROCESSING SOFTWARE TO ACCOMMODATE THE YEAR 2000 Like many financial institutions the Bank relies upon computers for the daily conduct of its business and for data processing generally. There is concern among industry experts that commencing on January 1, 2000, computers will be unable to "read" the new year and there may be widespread computer malfunctions. Management has begun an assessment of the electronic systems, programs, applications and other electronic components used in the operations of the Bank, and believes that the Bank has either programmed its hardware and software to be able to accurately recognize the year 2000, or implemented a plan pursuant to which the hardware and software will be programmed in the future. Management believes that significant additional costs will not be incurred in connection with the year 2000 issue, although there can be no assurances in this regard. Management continues to test the Bank's hardware and software to determine whether it will be able function accurately in the year 2000. IMPACT OF NEW ACCOUNTING STANDARDS In February 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 128 "Earnings Per Share." SFAS No. 128 supersedes APB Opinion No. 15 "Earnings Per Share" and specifies the computation, presentation and disclosure requirements for earnings per share ("EPS") for entities with publicly held stock or potential publicly held common stock. Essentially, this standard replaces the primary EPS and fully diluted EPS presentations under APB Opinion No. 15 with a basic EPS and diluted EPS presentation. SFAS No. 128 is effective for financial statements for both interim and annual periods ending after December 15, 1997, earlier application is not permitted. In February 1997, the FASB issued SFAS No. 129, "Disclosure of Information about Capital Structure." SFAS No. 129 summarizes previously issued disclosure guidance contained within APB Opinions Nos. 10 and 15 as well as SFAS No. 47. There will be no changes to the Bank's disclosures pursuant to the adoption of SFAS No. 129. This statement is effective for financial statements for periods ending after December 15, 1997. In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The comprehensive income and related cumulative equity impact of comprehensive income items will be required to be disclosed prominently as part of the notes to the financial statements. Only the impact of unrealized gains or losses on securities available for sale is expected to be disclosed as an additional component of the Bank's income under the requirements of SFAS No. 130. This statement is effective for fiscal years beginning after December 15, 1997. In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which changes the way public companies report information about segments of their business on their annual financial statements and requires them to report selected segment information in their quarterly reports issued to shareholders. It also requires entity wide disclosures about the products and services an entity provides, the foreign countries in which it holds assets and reports revenues, and its major customers. This statement is effective for fiscal years beginning after December 15, 1997. BUSINESS OF THE COMPANY 53 The Stock Company is currently not an operating company. Following the Reorganization, in addition to directing, planning and coordinating the business activities of the Bank, the Stock Company will initially invest net proceeds it retains primarily in short and medium-term investments. The Stock Company also intends to fund the loan to the ESOP to enable the ESOP to purchase 8% of the common stock sold in the Offering. In the future, the Stock Company may acquire or organize other operating subsidiaries, including other financial institutions and financial services companies. See "Use of Proceeds." Presently, there are no agreements or understandings for an expansion of the Stock Company's operations. Initially, the Stock Company will neither own nor lease any property from any third party, but will instead use the premises, equipment and furniture of the Bank. At the present time, the Stock Company does not intend to employ any persons other than certain officers of the Bank, who will not be separately provided cash compensation by the Stock Company. The Stock Company may utilize support staff of the Bank from time to time, if needed. Additional employees will be hired as appropriate to the extent the Stock Company expands its business in the future. BUSINESS OF THE BANK GENERAL The Bank operates, and intends to continue to operate, as a community oriented financial institution and is devoted to serving the needs of its customers. The Bank's business consists primarily of attracting retail deposits from the general public and using those funds to originate real estate, commercial and consumer loans. See "--Lending Activities." MARKET AREA All of the Bank's offices are located in the County of Gaston. The main office and two branches are located in the City of Gastonia, and one branch is located in the City of Mount Holly. Gaston County is located on the I-85 corridor in the Southern Piedmont region of North Carolina, not far from the regional banking center of Charlotte, North Carolina, and the South Carolina state line. Gaston County is bounded by the North Carolina Counties of Mecklenburg, Lincoln and Cleveland, and the South Carolina County of York. The Bank considers Gaston and these contiguous counties to be its primary market area. Gaston County has a population of approximately 183,000 and an economy based on manufacturing, especially textiles, apparel, fabricated metals, machinery, chemicals, and automotive transportation equipment, and has developed a strong base in service industries, especially construction and retail trade. Twenty-one Fortune 500 companies operate in Gaston County. Among the largest employers in Gaston County are Freightliner, Firestone, Parkdale Mills, Pharr Yarns, Dana Corporation, Gaston Memorial Hospital and Gaston College. The Bank faces intense competition from many financial institutions for deposits and loan originations. See "Risk Factors--Strong Competition Within the Bank's Market Area." LENDING ACTIVITIES General. At September 30, 1997, the Bank's net loans receivable totaled $134.5 million, or 77.5% of total assets at that date. The Bank has traditionally concentrated its lending activities on conventional first mortgage loans secured by one- to four-family properties, with such loans amounting to $106.4 million, or 76.5% of total loans receivable at September 30, 1997. In addition, the Bank originates construction loans, commercial real estate loans, multi-family residential real estate loans, land loans, commercial business loans and consumer loans. A substantial portion of the Bank's loan portfolio is secured by real estate, either as primary or secondary collateral, located in its primary market area. 54 Loan Portfolio Analysis. The following table sets forth the composition of the Bank's loan portfolio at the dates indicated. The Bank had no concentration of loans exceeding 10% of total gross loans other than as disclosed below.
At September 30, ------------------------------------------------- 1997 1996 --------------------- --------------------- Amount Percent Amount Percent ------ ------- ------ ------- (Dollars in Thousands) Real estate loans: One- to four-family........................... $ 106,422 76.50% $ 104,363 76.72% Construction.................................. 5,869 4.22 6,827 5.02 Commercial.................................... 7,318 5.26 6,458 4.75 Multi-family residential...................... 6,514 4.68 6,843 5.03 ---------- ------ ---------- ------- Total real estate loans.................... 126,123 90.66 124,491 91.52 Commercial business loans.......................... 5,558 4.00 5,160 3.79 Consumer loans: Home equity lines of credit................... 5,651 4.06 4,747 3.49 Loans on deposits............................. 688 0.49 709 0.52 Other......................................... 1,091 0.78 923 0.68 ---------- ------ ---------- ------- Total consumer loans...................... 7,430 5.34 6,379 4.69 ---------- ------ ---------- ------- Total loans................................... 139,111 100.00% 136,030 100.00% ====== ======= Less: Loans in process.............................. 2,990 3,812 Deferred loan origination fees................ 520 526 Allowance for loan losses..................... 1,110 830 ---------- ---------- Total loans, net................................... $ 134,491 $ 130,862 ========== ==========
One- to Four-Family Real Estate Lending. Historically, the Bank has concentrated its lending activities on the origination of loans secured by first mortgage loans on existing one- to four-family residences located in its primary market area. At September 30, 1997, $106.4 million, or 76.5% of the Bank's total loans receivable, consisted of one- to four-family residential real estate loans. The Bank originated $12.6 million and $18.5 million of one- to four-family residential mortgage loans during the fiscal years ended September 30, 1997 and 1996, respectively. Generally, the Bank's fixed-rate one- to four-family mortgage loans have maturities ranging from ten to 30 years and are fully amortizing with monthly payments sufficient to repay the total amount of the loan with interest by the end of the loan term. Generally, they are originated under terms, conditions and documentation which permit them to be sold to U.S. Government sponsored agencies such as Fannie Mae, although the Bank rarely sells fixed-rate loans. The Bank's fixed-rate loans customarily include "due on sale" clauses, which give the Bank 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. Management intends to institute a residential wholesale correspondent lending program in 1998. This program would authorize and enable the Bank to purchase one- to four-family residential mortgage loans from private mortgage bankers. The bank intends to confine this practice to select mortgage banking companies located only in North Carolina. The purpose of this program is to provide an additional medium by which the Bank can invest its new capital in conservative interest sensitive assets such as residential loan products with three, five, seven and ten year rate adjustments or balloons. 55 The Bank offers ARM loans at rates and terms competitive with market conditions. At September 30, 1997, $34.1 million, or 24.5% of the Bank's gross loan portfolio, were subject to periodic interest rate adjustments. Substantially all of the Bank's ARM loan originations meet the underwriting standards of Fannie Mae even though the Bank originates ARM loans primarily for its own portfolio. The Bank's ARM loans provide for an interest rate which adjusts every year based on the one year Treasury constant maturity index, although the Bank's portfolio includes less than $500,000 of loans based on other indices. The Bank's ARMs are typically based on up to a 30-year amortization schedule. For loans with a loan to value ratio of 80% or less, the Bank qualifies the borrowers on its ARM loans based on the initial rate. For loans with a loan to value ratio of more than 80%, the Bank qualifies the borrowers on its ARM loans based on the initial rate plus 2%. The Bank's current ARM loans do not provide for negative amortization. The Bank's ARM loans generally provide for annual and lifetime interest rate adjustment limits of 2% and 5 1/2%, respectively. The Bank offers discounted or "teaser" initial interest rates that may be more than 2% below the interest rate to which the loan would adjust after the first year based on the market rates of interest at the time the loan was originated. Borrower demand for ARM loans versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the level of interest rates and the difference between the initial interest rates and fees charged for each type of loan. The relative amount of fixed-rate mortgage loans and ARM loans that can be originated at any time is largely determined by the demand for each in a competitive environment. The retention of ARM loans in the Bank's loan portfolio helps reduce the Bank's 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. See "Risk Factors--Potential Changes in Interest Rates and the Current Interest Rate Environment." In addition, although ARM loans allow the Bank to increase the sensitivity of its 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, the Bank has no assurance that yields on ARM loans will be sufficient to offset increases in the Bank's cost of funds. The Bank believes these risks, which have not had a material adverse effect on the Bank to date, generally are less than the risks associated with holding fixed-rate loans in portfolio during a rising interest rate environment. The Bank generally requires title insurance insuring the status of its lien or an acceptable attorney's opinion on all loans where real estate is the primary source of security. The Bank also requires 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 the Bank's Board of Directors, the Bank can lend up to 95% of the appraised value of the property securing a one- to four-family residential loan. For loans of up to 80% of the appraised value of the property, the Bank does not require private mortgage insurance, for loans of more than 80% to up to 95% of the appraised value of the property, the Bank requires private mortgage insurance for between 20% and 30% of the amount of the loan. Construction Lending. The Bank originates residential construction loans to local home builders, generally with whom it has an established relationship, and to individuals who have a contract with a builder for the construction of their residence. The Bank's construction loans are generally secured by property located in the Bank's primary market area. At September 30, 1997, construction loans amounted to $5.9 million, or 4.2% of the Bank's total loan portfolio. The Bank's construction loans to home builders generally have fixed interest rates and are for a term of twelve months. Construction loans to individuals are typically made in connection with the granting of the permanent financing on the property. Construction loans to individuals convert to a fully amortizing adjustable- or fixed-rate loan at the end of the six month construction term; if the construction is not complete after six months, the Bank will generally modify the loan so that the term is for a period necessary to complete construction. Construction loans to 56 builders are typically originated with a maximum loan to value ratio of 80%. Construction loans to individuals are generally originated pursuant to the same policy regarding loan to value ratios as are used in connection with loans secured by one- to four-family residential real estate. The Bank's construction loans to builders are made on either a pre-sold or speculative (unsold) basis. However, the Bank generally limits the number of outstanding loans on unsold homes under construction to individual builders, with the amount dependent on the financial strength of the builder, the present exposure of the builder, the location of the property and prior sales of homes in the development. At September 30, 1997, speculative construction loans amounted to $2.5 million. At September 30, 1997, the largest amount of construction loans outstanding to one builder was $555,800. Prior to making a commitment to fund a construction loan, the Bank requires an appraisal of the property by an independent state-licensed and qualified appraiser approved by the Board of Directors. The Bank's staff or an independent appraiser retained by the Bank, 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, with all accrued interest collected at maturity. Construction lending affords the Bank the opportunity to charge higher interest rates with shorter terms to maturity relative to single-family permanent mortgage lending. Construction lending, however, is generally considered to involve a higher degree of risk than single-family permanent mortgage lending because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost of the project. 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, the Bank 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, the Bank may be confronted at or prior to the maturity of the loan with a project the value of which is insufficient to assure full repayment. Projects may also be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors. Loans to builders to construct homes for which no purchaser has been identified carry more risk because the payoff for the loan is dependent on the builder's ability to sell the property prior to the time that the construction loan is due. The Bank has attempted to minimize the foregoing risks by, among other things, limiting its construction lending primarily to residential properties and generally requiring personal guarantees from the principals of its corporate borrowers. Commercial Real Estate Lending. The Bank originates mortgage loans for the acquisition and refinancing of commercial real estate properties. At September 30, 1997, $7.3 million, or 5.2% of the Bank's total loan portfolio consisted of loans secured by commercial real estate properties. The majority of the Bank's commercial real estate properties are secured by office buildings, churches, and retail shops, which are generally located in the Bank's primary market area. The interest rates for the Bank's commercial 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, and are originated to amortize in a maximum of 20 years. At September 30, 1997, the average balance of the Bank's commercial real estate loans was $98,600, and the largest such loan had a balance of $664,000. The Bank requires appraisals of all properties securing commercial real estate loans. Appraisals are performed by an independent appraiser designated by the Bank, all of which are reviewed by management. The Bank considers the quality and location of the real estate, the credit of the borrower, the cash flow of the project and the quality of management involved with the property. Loan to value ratios on the Bank's commercial real estate loans are generally limited to 80% of the appraised value of the secured property. As part of the criteria for underwriting commercial real estate loans, the Bank generally imposes a debt coverage ratio (the ratio of net cash from operations before payment of debt service to debt service) 57 of not less than 1.25. It is also the Bank's policy to obtain personal guarantees from the principals of its corporate borrowers on its commercial real estate loans. The Bank originates a limited number of loans to existing customers to purchase real estate on which the borrower's principal residence will be constructed. The Bank does not solicit such land loans and such loans totaled $41,000 as of September 30, 1997. Commercial real estate lending affords the Bank 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 event of default and foreclosure the Bank 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. The Bank seeks to minimize these risks by limiting the maximum loan-to-value ratio and strictly scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. The Bank also obtains loan guarantees from financially capable parties based on a review of personal financial statements. Multi-Family Residential Real Estate Loans. The Bank originates mortgage loans secured by multi-family dwelling units (more than four units). At September 30, 1997, $6.5 million, or 4.7% of the Bank's total loan portfolio consisted of loans secured by multi-family residential real estate. The majority of the Bank's multi-family residential real estate loans are secured by apartment buildings located in the Bank's primary market area. The interest rates for the Bank's multi-family 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, and are originated to amortize in a maximum of 20 years. At September 30, 1997, the average balance of the Bank's multi-family residential real estate loans was $237,000, and the largest such loan had a balance of $1.2 million. The Bank requires appraisals of all properties securing multi-family residential real estate loans. Appraisals are performed by an independent appraiser designated by the Bank, all of which are reviewed by management. The Bank considers the quality and location of the real estate, the credit of the borrower, the cash flow of the project and the quality of management involved with the property. Loan-to-value ratios on the Bank's multi-family residential real estate loans are generally limited to 80%. As part of the criteria for underwriting multi-family residential real estate loans, the Bank generally imposes a debt coverage ratio (the ratio of net cash from operations before payment of debt service to debt service) of not less than 1.25. It is also the Bank's policy to obtain personal guarantees from the principals of its corporate borrowers on its multi-family residential real estate loans. Multi-family residential real estate lending affords the Bank 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 event of default and foreclosure the Bank 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 operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks by limiting the maximum loan-to-value ratio and strictly scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. The Bank also obtains loan guarantees from financially capable parties based on a review of personal financial statements. 58 Consumer Lending. The Bank originates a variety of consumer loans primarily on a secured basis. Consumer loans include home equity lines of credit, loans secured by savings accounts, automobiles, recreational vehicles and second mortgages, and unsecured personal loans. The Bank's home equity lines of credit 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. Other consumer loans are made with fixed interest rates and have terms that generally do not exceed five years. At September 30, 1997, consumer loans amounted to $7.4 million, or 5.2% of the total loan portfolio. At September 30, 1997, the largest component of the consumer loan portfolio consisted of home equity lines of credit, which totaled $5.7 million, or 4.1% of the total loan portfolio. At September 30, 1997, unused commitments to extend credit under home equity lines of credit totaled $6.4 million. The majority of the Bank's consumer loans are made to existing customers, although the Bank actively promotes consumer loans by contacting existing customers and by other promotions and advertising directed at existing and prospective customers. The Bank's consumer loans are originated on a secured and unsecured basis, and the secured loans on rare occasions may have loan balances that exceed the value of the collateral. The Bank views consumer lending as an important part of its business because consumer loans generally have shorter terms and higher yields, thus reducing exposure to changes in interest rates. In addition, the Bank believes that offering consumer loans helps to expand and create stronger ties to its customer base. Subject to market conditions, the Bank intends to continue emphasizing consumer lending. Consumer loans entail greater risk than do 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. The Bank believes that these risks are not as prevalent in the case of the Bank's consumer loan portfolio because a large percentage of the portfolio consists of home equity lines of credit that are underwritten in a manner such that they result in credit risk that is substantially similar to one- to- four family residential mortgage loans. Nevertheless, home equity lines of credit have greater credit risk than one- to four-family residential mortgage loans because they often are secured by mortgages subordinated to the existing first mortgage on the property, which may or may not be held by the Bank. At September 30, 1997, the Bank had no consumer loans that were delinquent in excess of 90 days. The Bank employs 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 a comparison of the value of the security, if any, to the proposed loan amount. The Bank generally underwrites and originates its consumer loans internally, which the Bank believes limits its exposure to credit risks associated with loans underwritten or purchased from brokers and other external sources. Commercial Business Loans. The Bank also originates commercial business loans, generally to customers who are well known to the Bank. Commercial business loans are frequently secured by real estate, although the decision to grant a commercial business loan depends primarily on the creditworthiness and cash flow of the borrower (and any guarantors) and secondarily on the value of and ability to liquidate the collateral. The Bank generally requires annual financial statements from its corporate borrowers and personal guarantees from the corporate principals. The Bank also generally requires an appraisal of any real estate that secures the loan. In addition, the Bank's portfolio of commercial business loans as of September 30, 1997 includes residential acquisition and development loans ("A&D loans"), all of which were made to builders with whom the Bank has a longstanding 59 relationship and are secured by real estate located in Gaston County. At September 30, 1997, the Bank had $5.6 million of commercial business loans which represented 4.0% of the total loan portfolio. On such date, the average balance of the Bank's commercial business loans was $70,426, and the largest such loan had a balance of $1.0 million. As of September 30, 1997, unsecured commercial business loans totaled $524,000. The Bank's A&D loans are originated to local developers for the purpose of developing land for sale by, for example, installing roads, sewers, water and other utilities. A&D loans are secured by a lien on the property, are made for a period of three years with interest rates that are tied to the Prime Rate. The Bank requires monthly interest payments during the term of the loan. The Bank's A&D loans are structured so that the Bank is repaid in full upon the sale by the borrower of approximately 75% of the available lots. All of the Bank's A&D loans are secured by property located in its primary market area. In addition, the Bank obtains personal guarantees from the principals of its corporate borrowers and generally originates A&D loans to developers with whom its has established relationships. 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. Real estate lending is generally considered to be collateral based, with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans may be collateralized 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, among other things. 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. Maturity of Loan Portfolio. The following table sets forth certain information at September 30, 1997 regarding the dollar amount of loans maturing in the Bank's 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 loans losses.
Real Estate Loans --------------------------------------------------- One- to Four- Multi- Commercial Family Family Business and Residential Construction Commercial Residential Consumer Total ------------- ------------ ---------- ----------- ------------ ----- (Dollars in Thousands) Amounts Due: Within 1 year.................. $ 619 $ 3,002 $ 3 $ -- $ 3,966 $ 7,590 Over 1 to 2 years.............. 73 133 14 -- 969 1,189 Over 2 to 3 years.............. 195 -- 17 -- 388 600 Over 3 to 5 years.............. 1,785 -- 670 40 965 3,460 Over 5 to 10 years............. 16,412 -- 1,529 984 443 19,368 Over 10 to 20 years............ 38,674 907 5,085 4,899 6,175 55,740 Over 20 years.................. 48,664 1,827 -- 591 82 51,164 -------- --------- --------- --------- --------- --------- Total amount due............... $106,422 $ 5,869 $ 7,318 $ 6,514 $ 12,988 $ 139,111 ======== ========= ========= ========= ========= =========
The following table sets forth the dollar amount of all loans for which final payment is not due until after September 30, 1998. The table also shows the amount of loans which have fixed rates of interest and those which have adjustable rates of interest. 60
Fixed Rates Adjustable Rates Total --------------- ---------------- ------------- (Dollars in Thousands) Real Estate Loans: One- to four-family residential $ 71,725 $ 34,078 $ 105,803 Construction 2,103 764 2,867 Commercial real estate 198 7,117 7,315 Multi-family residential -- 6,514 6,514 ------------- ------------- ------------- Total real estate loans 74,026 48,473 122,499 Commercial and consumer 1,422 7,600 9,022 ------------- ------------- ------------- Total loans $ 75,448 $ 56,073 $ 131,521 ============= ============= =============
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 the Bank 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 higher than current mortgage loan market rates. Furthermore, management believes that a significant number of the Bank's 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 its primary market area. Loan Solicitation and Processing. The Bank's lending activities are subject to the written, non-discriminatory, underwriting standards and loan origination procedures established by the Bank's Board of Directors and management. 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. The Bank also advertises its loan products by television and newspaper. In its marketing, the Bank emphasizes its community ties, customized personal service and an efficient underwriting and approval process. The Bank uses professional fee appraisers for most residential real estate loans and construction loans and all commercial real estate and land loans. The Bank requires hazard, title and, to the extent applicable, flood insurance on all security property. Mortgage loan applications are initiated by loan officers. All loans of $500,000 or more must be approved by the Board of Directors. Loans of less than $500,000 may be approved by the Bank's Loan Committee, a management committee consisting of the Bank's President and three senior lending officers. In addition, individual lending officers have lending authority up to limits established by the Board of Directors. 61 Loan Originations, Sales and Purchases. The following table sets forth total loans originated and repaid during the periods indicated.
For the Years Ended September 30, ------------------------ 1997 1996 ---- ---- (Dollars in Thousands) Total loans receivable at beginning of period........................ $ 136,030 $ 123,710 Total loan originations: One- to four-family residential................................... 12,608 18,466 Construction...................................................... 7,536 8,645 Commercial real estate............................................ 1,747 1,235 Multifamily....................................................... -- 2,513 Commercial business and consumer.................................. 9,430 10,360 ---------- ---------- Total loans originated............................................... 31,321 41,219 Loans purchased...................................................... -- 254 Principal repayments................................................. (28,240) (29,153) ---------- ---------- Net loan activity.................................................... 3,081 12,320 ---------- ---------- Total loans receivable at end of period.............................. $ 139,111 $ 136,030
Loan Commitments. The Bank issues 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 September 30, 1997, the Bank had loan commitments (excluding undisbursed portions of interim construction loans of $3.0 million) of $2.0 million and unused lines of credit of $9.5 million. See Note 8 of Notes to the Consolidated Financial Statements. Loan Fees. In addition to interest earned on loans, the Bank receives income from fees in connection with loan originations, loan modifications, late payments and for miscellaneous services related to its loans. Income from these activities varies from period to period depending upon the volume and type of loans made and competitive conditions. The Bank charges loan origination fees which are calculated as a percentage of the amount borrowed. In accordance with applicable accounting procedures, 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. The Bank recognized $172,000 and $131,000 of deferred loan fees during the fiscal years ended September 30, 1997 and 1996, 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, the Bank attempts to cure the deficiency by contacting the borrower and seeking 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 or other means and the Bank will attempt to work out a payment schedule and actively encourage delinquent borrowers to seek home ownership counseling. While the Bank generally prefers to work with borrowers to resolve such problems, the Bank 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 62 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. The Bank's Board of Directors is informed monthly of the status of all mortgage loans delinquent more than 60 days, all consumer and commercial business loans delinquent more than 30 days, all loans in foreclosure and all foreclosed and repossessed property owned by the Bank. The following table sets forth information with respect to the Bank's nonperforming assets at the dates indicated. As of such dates, the Bank had no restructured loans within the meaning of SFAS No. 15.
At September 30, ------------------ 1997 1996 ---- ---- (Dollars in Thousands) Loans accounted for on a nonaccrual basis: One- to four-family residential real estate loans $ 876 $ 1,053 Multi-family residential real estate loans 183 141 --------- --------- Total nonaccrual loans 1,059 1,194 Accruing loans which were contractually past due 90 days or more -- -- --------- --------- Total nonperforming loans 1,059 1,194 Real estate owned 247 258 --------- --------- Total nonperforming assets $ 1,306 $ 1,452 ========= ========= Nonaccrual loans and loans 90 days past due as a percentage of net loans 0.79% 0.91% ========= ========= Nonaccrual loans and loans 90 days past due as a percentage of total assets 0.76% 0.88% ========= ========= Total nonperforming assets as a percentage of total assets 0.75% 0.84% ========= =========
Interest income that would have been recorded for the fiscal years ended September 30, 1997 and 1996 had nonaccruing loans been current in accordance with their original terms amounted to $42,000 and $46,000, respectively. The Bank did not include any interest income on such loans for such periods. Real Estate Acquired in Settlement of Loans. Real estate acquired by the Bank as a result of foreclosure or by deed-in-lieu of foreclosure is classified as real estate acquired in settlement of loans until sold. Pursuant to American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 92-3, which provides guidance on determining the balance sheet treatment of foreclosed assets in annual financial statements for periods ended on or after December 15, 1992, there is a rebuttal presumption that foreclosed assets are held for sale and such assets are recommended to be 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. The Bank's accounting for its real estate acquired in settlement of loans complies with SOP 92-3. At September 30, 1997, the Bank had $246,700 of real estate acquired in settlement of loans. Restructured Loans. Under GAAP, the Bank is 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 the Bank for economic or legal reasons related to the borrower's financial difficulties grants a concession to the borrowers that the Bank 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. The Bank had no restructured loans as of September 30, 1997. Asset Classification. The OTS has adopted various regulations regarding problem assets of savings 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 63 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 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 the Bank. As of September 30, 1997, the aggregate amount of the Bank's assets classified as substandard was $2.3 million, no assets were classified as doubtful or loss, and the aggregate amount not classified but designated special mention was $312,000. As of September 30, 1996, the aggregate amount of the Bank's assets classified as substandard was $2.3 million, no assets were classified as doubtful or loss, and the aggregate amount not classified but designated special mention was $432,000. Allowance for Loan Losses. The Bank has established a systematic methodology for the determination of provisions for loan losses. The methodology is set forth in a formal policy and takes into consideration the need for an overall general valuation allowance as well as specific allowances that are tied to individual loans. In originating loans, the Bank recognizes 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 for the loan. The Bank increases its allowance for loan losses by charging provisions for loan losses against the Bank's income. The general valuation allowance is maintained to cover losses inherent in the loan portfolio. Management's periodic evaluation of the adequacy of the allowance is based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. Specific valuation allowances are established to absorb losses on loans for which full collectibility cannot be reasonably assured. The amount of the allowance is based on the estimated value of the collateral securing the loan and other analyses pertinent to each situation. Generally, a provision for losses is charged against income monthly to maintain the allowances. At September 30, 1997, the Bank had an allowance for loan losses of $1.1 million. Management believes that the amount maintained in the allowance at September 30, 1997 will be adequate to absorb losses inherent in the portfolio. 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 and adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while the Bank believes it has established its existing allowance for loan losses in accordance with GAAP, there can be no assurance that regulators, in reviewing the Bank's loan portfolio, will not request the Bank to increase significantly its allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect the Bank's financial condition and results of operations. 64 The following table sets forth an analysis of the Bank's allowance for loan losses.
At and For the Fiscal Years Ended September 30, ------------------------------- 1997 1996 ----------- ----------- (Dollars in Thousands) Total loans outstanding.............................................. $ 134,491 $ 130,862 =========== ============ Average loans outstanding............................................ $ 132,529 $ 126,503 =========== ============ Allowance at beginning of period..................................... $ 830 $ 786 Provision............................................................ 293 47 Recoveries........................................................... -- -- Charge-offs: Consumer loans.................................................... 13 3 ----------- ------------ Allowance at end of period........................................... $ 1,110 $ 830 =========== ============ Allowance for loan losses as a percentage of total loans outstanding................................................ 0.83% 0.63% ========== =========== Net loans charged off as a percentage of total loans outstanding..... 0.01% --% ========== =========== Ratio of allowance to nonperforming loans............................ 104.82% 69.51% ========== ===========
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.
At September 30, --------------------------------------------------------------- 1997 1996 ---------------------------- ---------------------------- Percent of Percent of Loans in Each Loans in Each Category to Category to Amount Total Loans Amount Total Loans ------ ------------- ------ ------------- (Dollars in Thousands) Real estate loans: One- to Four-family residential...... $ 643 76.50% $ 450 76.72% Construction......................... 55 4.22 50 5.02 Commercial........................... 105 5.26 88 4.75 Multi-family residential............. 100 4.68 75 5.03 Commercial and consumer................... 207 9.34 167 8.48 ---------- --------- --------- --------- Total allowance for loan losses........... $ 1,110 100.00% $ 830 100.00% ========== ========= ========= =========
INVESTMENT ACTIVITIES The Bank is permitted under federal law to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and of state and municipal governments, deposits at the FHLB-Atlanta, certificates of deposit of federally insured institutions, certain bankers' acceptances and federal funds. Subject to various restrictions, the Bank may also invest a portion of its assets in commercial paper and corporate debt securities. Savings institutions like the Bank are also required to maintain an investment in FHLB stock. The Bank is required under federal regulations to maintain a minimum amount of liquid assets. See "Regulation" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." 65 The Bank purchases investment securities with excess liquidity arising when investable funds exceed loan demand. The Bank's investment securities purchases have been limited to U.S. Government and agency securities generally with contractual maturities of between one and five years. The Bank's investment policies generally limit investments to U.S. Government and agency securities, municipal bonds, certificates of deposit, marketable corporate debt obligations, mortgage-backed securities and certain types of mutual funds. The Bank's investment policy does not permit engaging directly in hedging activities or purchasing high risk mortgage derivative products or non-investment grade corporate bonds. Mutual funds held by the Bank may periodically engage in hedging activities and invest in derivative securities. Investments are made based on certain considerations, which include the interest rate, yield, settlement date and maturity of the investment, the Bank's 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 the Bank's 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.
At September 30, ------------------------------------------------------------- 1997 1996 ----------------------------- ---------------------------- Net Net Amortized Unrealized Fair Amortized Unrealized Fair Cost Gain(Loss) Value Cost Gain(Loss) Value --------- ---------- ----- --------- ---------- ----- (Dollars in Thousands) Investment Securities: U.S. Government and agency securities held to maturity....................... $ 10,407 $ 18 $ 10,425 $ 14,751 $ (88) $ 14,663 U.S. Government and agency securities available for sale..................... 1,988 22 2,010 -- -- -- -------- -------- -------- -------- --------- --------- Total investment securities................. $ 12,395 $ 40 $ 12,435 $ 14,751 $ (88) $ 14,663 ======== ======== ======== ======== ========= ========= Mortgage-backed securities: FHLMC held to maturity................... $ 5,238 $ 94 $ 5,332 $ 6,813 $ 15 $ 6,828 FNMA held to maturity.................... 3,588 (18) 3,570 4,663 (94) 4,569 GNMA held to maturity.................... 1,261 30 1,291 1,442 7 1,449 -------- -------- -------- -------- --------- --------- Total mortgage-backed securities............ $ 10,087 $ 106 $ 10,193 $ 12,918 $ (72) $ 12,846 ======== ======== ======== ======== ========= ========= Other Investments available for sale: US League Asset Management Fund.......... $ 1,375 $ 14 $ 1,389 $ 1,295 $ 9 $ 1,304 Federated Government Trust............... 3,036 228 3,264 2,861 183 3,044 FHLMC stock.............................. 44 1,542 1,586 44 1,073 1,117 Other.................................... -- -- -- 50 -- 50 -------- -------- -------- -------- --------- --------- Total other investments available for sale.. $ 4,455 $ 1,784 $ 6,239 $ 4,250 $ 1,265 $ 5,515 ======== ======== ======== ========= ========= =========
(1) All other investments are classified as available for sale. 66 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 September 30, 1997 by contractual maturity. The following table does not take into consideration the effects of scheduled repayments or the effects of possible prepayments.
At September 30, 1997 ----------------------------------------------------------------------------------------------------- Less than 1 year 1 to 5 years Over 5 to 10 years Over 10 years ---------------------- ---------------------- ---------------------- ---------------------- Weighed Weighted Weighted Weighted Carrying Average Carrying Average Carrying Average Carrying Average Value Yield(1) Value Yield(1) Value Yield(1) Value Yield(1) (Dollars in Thousands) U.S. Government securities $ 1,000 5.59% $ 2,503 6.33% $ -- --% $ -- --% U.S. Agency securities 1,049 5.63 7,617 6.38 -- -- 248 7.58 -------- ---- --------- ---- ----- ---- ------ ---- Total $ 2,049 5.63% $ 10,120 6.38% $ -- --% $ 248 7.58% ======== ==== ========= ==== ===== ==== ====== ==== At September 30, 1997 ----------------------------------- Total Securities ----------------------------------- Weighted Carrying Average Market Value Yield(1) Value (Dollars in Thousands) U.S. Government securities $ 3,502 6.12% $ 3,506 U.S. Agency securities 8,914 6.34 8,928 --------- ---- --------- Total $ 12,416 6.28% $ 12,434 ========= ==== =========
- -------------------- (1) Yields on tax exempt obligations have been computed on a tax equivalent basis. 67 DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS General. Deposits are the major external source of funds for the Bank's lending and other investment activities. In addition, the Bank also generates 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 FHLB-Atlanta may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. Presently, the Bank has no other borrowing arrangements. Deposit Accounts. The Bank's deposit products include a broad selection of deposit instruments, including NOW accounts, demand deposit accounts, money market accounts, regular passbook savings, statement savings accounts and term certificate accounts. Deposit account terms vary with the principal difference being the minimum balance deposit, early withdrawal penalties and the interest rate. The Bank reviews its deposit mix and pricing weekly. The Bank does not utilize brokered deposits, nor has it aggressively sought jumbo certificates of deposit. The Bank believes it is competitive in the type of accounts and interest rates it offers on its deposit products. The Bank does not seek to pay the highest deposit rates but a competitive rate. The Bank determines the rates paid based on a number of conditions, including rates paid by competitors, rates on U.S. Treasury securities, rates offered on various FHLB-Atlanta lending programs, and the deposit growth rate the Bank is seeking to achieve. The Bank may use premiums to attract new checking accounts, particularly in conjunction with new branch openings. Should they be used, these premium offers would be reflected in an increase in the Bank's advertising and promotion expense, as well as its cost of funds. The Bank also plans to seek business checking accounts and to promote individual retirement accounts ("IRAs") and Self Employment Plan retirement accounts to businesses. In the unlikely event the Bank is liquidated after the Reorganization, depositors will be entitled to full payment of their deposit accounts before any payment is made to the Stock Company as the sole stockholder of the Bank. 68 The following table sets forth information concerning the Bank's time deposits and other interest-bearing deposits at September 30, 1997.
Balance Minimum (in thousands) Percentage Balance as of September of Total Category Term Interest Rate Amount 30, 1997 Deposits - -------- ------------- ------------- ------- --------------- ---------- Non-interest NOW accounts None --% $ 100 $ 3,023 2.08% NOW accounts None 1.99% $ 100 6,763 4.65 Super Now accounts None 3.05% $ 1,000 4,903 3.37 Money market accounts None 3.05% $ 1,000 14,240 9.79 Passbook accounts None 2.79% $ 100 14,197 9.76 Certificates of deposit 91 days 4.34% $ 500 1,101 0.76 Certificates of deposit 6 months 5.23% $ 500 30,466 20.95 Certificates of deposit 12 months 5.31% $ 500 16,996 11.69 Certificates of deposit 18 months 5.35% $ 500 3,692 2.54 Certificates of deposit 24 months 6.02% $ 500 3,962 2.72 Certificates of deposit 30 months 6.16% $ 500 10,849 7.46 Certificates of deposit 36 months 5.93% $ 500 2,344 1.61 Certificates of deposit(1) Various 5.86% $ 50,000 13,862 9.53 Certificates of deposit variable rate IRA 18 months 5.48% $ 25 70 0.05 Certificates of deposit fixed rate IRA 18 months 5.44% $ 500 18,975 13.05 -------- ------ Total deposits $145,444 100.00% ======== ======
- ---------- (1) Generally includes "jumbo" and "mini-jumbo" deposits ($50,000 or more); however, it includes all deposits which have a negotiated interest rate higher than the standard rate offered at the time the deposit was accepted. The following table indicates the amount of the Bank's certificate accounts with a principal balance greater than $100,000 by time remaining until maturity as of September 30, 1997. Maturity Period Certificates of Deposit - --------------- ----------------------- (Dollars in Thousands) Within three months...................................... $ 4,197 Three to six months...................................... 7,056 Six through twelve months................................ 4,848 Over twelve months....................................... 1,511 --------- Total jumbo certificates of deposit................... $ 17,612 ========= Deposit Flow. The following table sets forth the balances (inclusive of interest credited) and changes in dollar amounts of deposits in the various types of accounts offered by the Bank between the dates indicated. 69 Time Deposits by Rates. The following table sets forth the amount of time deposits in the Bank categorized by rates at the dates indicated.
As of September 30, --------------------------- 1997 1996 ---------- ---------- (Dollars in Thousands) Interest Rate - ------------- 2.00-4.00%......................................................... $ 172 $ 24 4.01-6.00%......................................................... 92,311 84,163 6.01-8.00%......................................................... 9,835 21,902 ---------- ---------- $ 102,318 $ 106,089 ========== ==========
Time Deposits by Maturities. The following table sets forth the amount of time deposits in the Bank categorized by rates and maturities at September 30, 1997.
After Interest Rate September 30, 1998 September 30, 1999 September 30, 2000 September 30, 2000 Total - ------------- ------------------ ------------------ ------------------ ------------------- ----- (Dollars in Thousands) 2.01-4.0%........ $ 127 $ 45 $ -- $ -- $ 172 4.01-6.0%........ 78,747 99,931 3,630 3 92,311 6.01-8.0%........ 8,825 650 250 110 9,835 --------- --------- --------- -------- --------- Total............ $ 87,699 $ 10,626 $ 3,880 $ 113 $ 102,318 ========= ========= ========= ======== =========
Deposit Activity. The following table set forth the deposit activity of the Bank for the periods indicated.
Year Ended September 30, ------------------------ 1997 1996 ---- ---- (Dollars in Thousands) Beginning balance.................................................... $ 145,975 $ 141,432 Net increase (decrease) before interest credited..................... (7,386) (2,751) Interest credited.................................................... 6,805 7,294 ---------- ---------- Net increase (decrease) in savings deposits.......................... (531) 4,543 ---------- ---------- Ending balance....................................................... $ 145,444 $ 145,975 ========== ==========
Borrowings. Savings deposits are the primary source of funds for the Bank's lending and investment activities and for its general business purposes. The Bank has the ability to use advances from the FHLB- Atlanta to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB-Atlanta functions as a central reserve bank providing credit for savings associations and certain other member financial institutions. As a member of the FHLB-Atlanta, the Bank is required to own capital stock in the FHLB-Atlanta and is authorized to apply for advances on the security of such stock and certain of its 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 maximum outstanding balances of the Bank's FHLB advances for the fiscal years ended September 30, 1997 and 1996 were $3.8 million and $3.8 million, respectively, the average balances outstanding were $2.3 million and $1.6 million, respectively, and the weighted average interest rates were 6.28% and 4.36%, respectively. The Bank's outstanding balances of FHLB advances as of September 30, 1997 and 1996, were $3.5 million and $3.8 million, respectively. 70 COMPETITION The Bank faces intense competition in its primary market area for the attraction of savings deposits (its primary source of lendable funds) and in the origination of loans. Its most direct competition for savings deposits has historically come from commercial banks, credit unions, other thrifts operating in its market area, and other financial institutions such as brokerage firms and insurance companies. As of June 1996, the Bank ranked fourth in deposit share among depository institutions in Gaston County, with approximately 9.9% of the County's deposits. As of September 30, 1997, there were 38 financial institutions, including commercial banks, thrifts and credit unions operating in Gaston County, North Carolina. Particularly in times of high interest rates, the Bank has faced additional significant competition for investors' funds from short-term money market securities and other corporate and government securities. The Bank's competition for loans comes from commercial banks, thrift institutions, credit unions and mortgage bankers. Such competition for deposits and the origination of loans may limit the Bank's growth in the future. See "Risk Factors--Strong Competition Within the Bank's Market Area." SUBSIDIARY ACTIVITIES Under OTS regulations, the Bank generally may invest up to 3% of its assets in service corporations, provided that at least one-half of investment in excess of 1% is used primarily for community, inner-city and community development projects. The Bank's investment in its wholly-owned service corporation, Gaston Financial Services, Inc. doing business as Gaston Federal Investment Services ("GFS") which was $533,399 at September 30, 1997, did not exceed these limits. A licensed insurance agent, GFS markets annuities, mutual funds and life insurance, and provides discount brokerage services. PROPERTIES The following table sets forth certain information regarding the Bank's offices at September 30, 1997, all of which are owned by the Bank.
Location Year Opened Approximate Square Feet Deposits - -------- ----------- ----------------------- -------- 245 West Main Avenue 1971 12,400 $43.4 million Gastonia, NC 28052-4140 1670 Neal Hawkins Road 1987 5,322 $21.4 million Gastonia, NC 28056-6429 1535 Burtonwood Drive 1976 4,739 $44.7 million Gastonia, NC 28054-4011 233 South Main Street 1990 2,372 $36.1 million Mount Holly, NC 28120-1620
At September 30, 1997, the net book value of the Bank's office properties and the Bank's fixtures, furniture, and equipments was $2.1 million. EMPLOYEES As of September 30, 1997, the Bank had 57 full-time and 8 part-time employees, none of whom is represented by a collective bargaining unit. The Bank believes its relationship with its employees is good. 71 LEGAL PROCEEDINGS Periodically, there have been various claims and lawsuits involving the Bank, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Bank's business. The Bank is not a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Bank. FEDERAL AND STATE TAXATION FEDERAL TAXATION General. The Mutual Company, the Stock Company and the Bank will be 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 the Bank. Method of Accounting. For federal income tax purposes, the 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 (the "1996 Act") 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 1996 Act, the 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 the Bank's taxable income. As a result of the 1996 Act, the 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 September 30, 1997, was approximately $1.4 million Taxable Distributions and Recapture. Prior to the 1996 Act, bad debt reserves created prior to January 1, 1988 were subject to recapture into taxable income should the 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 the Bank make certain non-dividend distributions or cease to maintain a bank charter. At September 30, 1997, the Bank's total federal pre-1988 reserve was approximately $4.8 million. This reserve reflects the cumulative effects of federal tax deductions by the 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. The 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 two taxable years and forward to the succeeding 20 taxable years. This provision applies to losses incurred in taxable years beginning after 1986. At September 30, 1997, the Bank had no net operating loss carryforwards for federal income tax purposes. 72 Corporate Dividends-Received Deduction. The Stock Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. Following completion of the Reorganization and Offering, the Mutual Company will own less than 80% of the outstanding common stock of the Stock Company. As such, the Mutual Company will not be permitted to file a consolidated federal income tax return with the Stock Company and the 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. Status of Examination. The Bank's federal income tax returns have been audited by the IRS, and are closed, through the fiscal year ended September 30, 1994. The IRS has not notified the Bank of any intention to audit the Bank's federal income tax returns for any subsequent year. STATE TAXATION State of North Carolina. Under North Carolina law, the corporate income tax is 7.75% of federal taxable income as computed under the Code, subject to certain prescribed adjustments. In addition, for tax years beginning in 1991, 1992, 1993 and 1994, corporate taxpayers were required to pay a surtax equal to 4%, 3%, 2% and 1%, respectively, of the state income tax otherwise payable by it. An annual state franchise tax is imposed at a rate of 0.15% applied to the greatest of the institutions (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. REGULATION As a federally chartered SAIF-insured stock savings bank, the Bank is subject to examination, supervision and extensive regulation by the OTS and the FDIC. The Bank is a member of the Federal Home Loan Bank ("FHLB") system. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The Bank also is subject to regulation by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") governing reserves to be maintained against deposits and certain other matters. The OTS examines the Bank and prepares reports for the consideration of the Bank's Board of Directors on any deficiencies that they may find in the Bank's operations. The FDIC also examines the Bank in its role as the administrator of the SAIF. The Bank's relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws especially in such matters as the ownership of savings accounts and the form and content of the Bank's mortgage documents. Any change in such regulation, whether by the FDIC, OTS, or Congress, could have a material adverse impact on the Stock Company and the Bank and their operations. FEDERAL REGULATION OF SAVINGS INSTITUTIONS Business Activities. The activities of savings institutions are governed by the Home Owners' Loan Act, as amended (the "HOLA") and, in certain respects, the Federal Deposit Insurance Act (the "FDI Act") and the regulations issued by the agencies to implement these statutes. These laws and regulations delineate the nature and extent of the activities in which savings association may engage. The description of statutory provisions and regulations applicable to savings associations set forth herein does not purport to be a complete description of such statutes and regulations and their effect on the Bank. Loans to One Borrower. Under the HOLA, savings institutions are generally subject to the national bank limits on loans to a single or related group of borrowers. Generally, this limit is 15% of the Bank's unimpaired capital and surplus plans and an additional 10% of unimpaired capital and surplus, if such loan is secured by readily- marketable collateral, which is defined to include certain financial instruments and bullion. The OTS by regulation has amended the loans to one borrower rule to permit savings associations meeting certain requirement to extend loans 73 to one borrower in additional amounts under circumstances limited essentially to loans to develop or complete residential housing units. Qualified Thrift Lender Test. In general, savings associations are required to maintain at least 65% of their portfolio assets in certain qualified thrift investments (which consist primarily of loans and other investments related to residential real estate and certain other assets). A savings association that fails the qualified thrift lender test is subject to substantial restrictions on activities and to other significant penalties. Recent legislation permits a savings association to qualify as a qualified thrift lender not only by maintaining 65% of portfolio assets in qualified thrift investments (the "QTL test") but also, in the alternative, by qualifying under the Code as a "domestic building and loan association." The Bank is a domestic building and loan association as defined in the Code. Recent legislation also expands the QTL test to provide savings associations with greater authority to lend and diversify their portfolios. In particular, credit card and education loans may now be made by savings associations without regard to any percentage-of-assets limit, and commercial loans may be made in an amount up to 10 percent of total assets, plus an additional 10 percent for small business loans. Loans for personal, family and household purposes (other than credit card, small business and educational loans) are now included without limit with other assets that, in the aggregate, may account for up to 20% of total assets. At September 30, 1997, under the expanded QTL test, approximately 88.8% of the Bank's portfolio assets were qualified thrift investments. Limitation on Capital Distributions. OTS regulations impose limitations upon all capital distributions by savings institutions, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to stockholders of another institution in a cash-out merger and other distributions charged against capital. The rule establishes three tiers of institutions, which are based primarily on an institution's capital level. An institution, such as the Bank, that exceeds all fully phased-in capital requirements before and after a proposed capital distribution ("Tier 1 Association") and has not been advised by the OTS that it is in need of more than normal supervision, could, after prior notice but without the approval of the OTS, make capital distributions during a calendar year equal to the greater of: (i) 100% of its net earnings to date during the calendar year plus the amount that would reduce by one-half its "surplus capital ratio" (the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year; or (ii) 75% of its net earnings for the previous four quarters; provided that the institution would not be undercapitalized, as that term is defined in the OTS Prompt Corrective Action regulations, following the capital distribution. Any additional capital distributions would require prior regulatory approval. In the event the Bank's capital fell below its fully-phased in requirement or the OTS notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the OTS could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. Liquidity. The Bank is required to maintain an average daily balance of specified liquid assets equal to a monthly average of not less than a specified percentage (currently 4%) of its net withdrawable deposit accounts plus borrowings payable in one year or less. Monetary penalties may be imposed for failure to meet these liquidity requirements. The Bank's average liquidity ratio for the quarter ended September 30, 1997 was 13.5%, which exceeded the then applicable requirements. The Bank has never been subject to monetary penalties for failure to meet its liquidity requirements. Community Reinvestment Act and Fair Lending Laws. Savings association share a responsibility under the Community Reinvestment Act ("CRA") and related regulations of the OTS to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act (together, the "Fair Lending Laws") prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An institution's failure to comply with the provisions of CRA could, at a minimum, result in regulatory restrictions on its activities, and failure to complete with the Fair Lending Laws could result in enforcement actions by the OTS, as well as other federal regulatory agencies 74 and the Department of Justice. The Bank received a satisfactory CRA rating under the current CRA regulations in its most recent federal examination by the OTS. Transactions with Related Parties. The Bank's authority to engage in transactions with related parties or "affiliates" (i.e., any company that controls or is under common control with an institution, including the Stock Company and any non-savings institution subsidiaries) or to make loans to certain insiders, is limited by Sections 23A and 23B of the Federal Reserve Act ("FRA"). Section 23A limits the aggregate amount of transactions with any individual affiliate to 10% of the capital and surplus of the savings institution and also limits the aggregate amount of transactions with all affiliates to 20% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in Section 23A and the purchase of low quality assets from affiliates is generally prohibited. Section 23B provides that certain transactions with affiliates, including loans and asset purchases, must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. Enforcement. Under the FDI Act, the OTS has primary enforcement responsibility over savings institutions and has the authority to bring enforcement action against all "institution-related parties," including stockholders, and any 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 institutions, 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. Under the FDI Act, the FDIC has the authority to recommend to the Director of OTS that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Standards for Safety and Soundness. The FDI Act requires each federal banking agency to prescribe for all insured depository institutions standards relating to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, and compensation fees and benefits and such other operational and managerial standards as the agency deems appropriate. The federal banking agencies adopted a final regulation and Interagency Guidelines Prescribing Standards for Safety and Soundness ("Guidelines") to implement the safety and soundness standards required under the FDI Act. 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 system; credit underwriting; loan documentation; interest rate risk exposure; asset growth; and 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, as required by the FDI Act. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans. Capital Requirements. The OTS capital regulations require savings institutions to meet three capital standards: a 1.5% tangible capital standard, a 3% leverage (core capital) ratio and an 8% risk based capital standard. Core capital is defined as common stockholder's equity (including retained earnings), certain non-cumulative perpetual preferred stock and related surplus, minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights ("MSRs") and credit card relationships. The OTS regulations require that, in meeting the leverage ratio, tangible and risk-based capital standards institutions generally must deduct investments in and loans to subsidiaries engaged in activities not permissible for a national bank. In addition, the OTS prompt corrective action regulation provides that a savings institution that has a leverage capital ratio of less than 4% (3% for institutions receiving the highest CAMELS examination rating) will be deemed to be "undercapitalized" and may be subject to certain restrictions. See "--Prompt Corrective Regulatory Action." 75 The risk-based capital standard for savings institutions requires the maintenance of total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of 8%. In determining the amount of risk- weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight of 0% to 100%, as assigned by the OTS capital regulation based on the risks OTS believes are inherent in the type of asset. The components of core capital are equivalent to those discussed earlier under the 3% leverage standard. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock and, within specified limits, the allowance for loan and lease losses. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. The OTS has incorporated an interest rate risk component into its regulatory capital rule. The final interest rate risk rule also adjusts the risk-weighting for certain mortgage derivative securities. Under the rule, savings associations with "above normal" interest rate risk exposure would be subject to a deduction from total capital for purposes of calculating their risk-based capital requirements. A savings association's interest that risk is measured by the decline in the net portfolio value of its assets (i.e., the difference between incoming and outgoing discounted cash flows from assets, liabilities and off-balance sheet contracts) that would result from a hypothetical 200-basis point increase or decrease in market interest rates divided by the estimated economic value of the association's assets, as calculated in accordance with guidelines set forth by the OTS. A savings association whose measured interest rate risk exposure exceeds 2% must deduct an interest rate component in calculating its total capital under the risk-based capital rule. The interest rate risk component is an amount equal to one-half of the difference between the institution's measured interest rate risk and 2%, multiplied by the estimated economic value of the association's assets. That dollar amount is deducted from an association's total capital in calculating compliance with its risk-based capital requirement. Under the rule, there is a two quarter lag between the reporting date of an institution's financial data and the effective date for the new capital requirement based on that data. A savings association with assets of less than $300 million an risk-based capital ratios in excess of 12% is not subject to the interest rate risk component, unless the OTS determines otherwise. The rule also provides that the Director of the OTS may waive or defer an association's interest rate risk component on a case-by-case basis. The OTS has postponed the date that the component will first be deducted from an institution's total capital to provide it with an opportunity to review the interest rate risk approaches taken by the other federal banking agencies. At September 1997, the Bank met each of its capital requirements, in each case on a fully phased-in basis. See "Regulatory Capital Compliance" for a table which sets forth in terms of dollars and percentages the OTS tangible, leverage and risk-based capital requirements, the Bank's historical amounts and percentages at September 30, 1997, and pro forma amounts and percentages based upon the issuance of the shares within the Offering Range and assuming that a portion of the net proceeds are retained by the Stock Company. Thrift Charter. Congress has been considering legislation in various forms that would require federal thrifts, such as the Bank, to convert their charters to national or state bank charters. Recent legislation required the Treasury Department to prepare for Congress a comprehensive study on development of a common charter for federal savings association and commercial banks; and, in the event that the thrift charter was eliminated by January 1, 1999, would require the merger of the BIF and the SAIF into a single deposit insurance fund on that date. The Bank cannot determine whether, or in what form, such legislation may eventually be enacted and there can be no assurance that any legislation that is enacted would not adversely affect the Bank and the Stock Company. PROMPT CORRECTIVE REGULATORY ACTION Under the OTS Prompt Corrective Action regulations, the OTS is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of capitalization. Generally, a savings institution that has total risk-based capital of less than 8.0% or a leverage ratio or a Tier 1 core capital ratio that is less than 4.0% is considered to be undercapitalized. A savings institution that has the total risk- based capital less than 6.0%, a Tier 1 core risk-based capital ratio of less than 3.0% or a leverage ratio that is less 76 than 3.0% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to assets ratio equal to or less than 2.0% is deemed to be "critically undercapitalized." Subject to a narrow exception, the banking regulator is required to appoint a receiver or conservator for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the OTS within 45 days of the date an institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to the institution, including, but not limited to, restrictions on growth, investment activities, capital distributions, and affiliate transactions. The OTS could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. INSURANCE OF DEPOSIT ACCOUNTS The FDIC has adopted a risk-based insurance assessment system. The FDIC assigns an institution to one of three capital categories based on the institution's financial information, as of the reporting period ending seven months before the assessment period, consisting of (1) well capitalized, (2) adequately capitalized or (3) undercapitalized, and one of three supervisory subcategories within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution's primary federal regulator and information which the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance funds. An institution's assessment rate depends on the capital category and supervisory category to which it is assigned. The FDIC is authorized to raise the assessment rates in certain circumstances. The FDIC has exercised this authority several times in the past and may raise insurance premiums in the future. If such action is taken by the FDIC, it could have an adverse effect on the earnings of the Bank. FEDERAL HOME LOAN BANK SYSTEM The Bank is a member of the FHLB System, which consists of 12 regional FHLBs. The FHLB provides a central credit facility primarily for member institutions. The Bank, as a member of the FHLB, is required to acquire and hold shares of capital stock in that FHLB 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 advances (borrowings) from the FHLB, whichever is greater. As of September 30, 1997, the Bank was in compliance with this requirement. The FHLBs are required to provide funds for the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the FHLBs pay to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. FEDERAL RESERVE SYSTEM The Federal Reserve Board regulations require savings institutions to maintain non-interest-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). At September 30, 1997, the Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the FRB may be used to satisfy liquidity requirements imposed by the OTS. HOLDING COMPANY REGULATION Generally. The Mutual Company and the Stock Company are non-diversified mutual savings and loan holding companies within the meaning of the HOLA, as amended. As such, the Mutual Company and the Stock Company are registered with the OTS and are subject to OTS regulations, examinations, supervision and reporting requirements. In addition, the OTS has enforcement authority over the Mutual Company and the Stock Company and any non-savings institution subsidiaries. Among other things, this authority permits the OTS to restrict or prohibit 77 activities that are determined to be a serious risk to the subsidiary savings institution. As federal corporations, the Stock Company and the Mutual Company are generally not subject to state business organizations law. Permitted Activities. Pursuant to Section 10(o) of the HOLA and OTS regulations and policy, a mutual holding company and a federally chartered mid-tier holding company such as the Stock Company may engage in the following activities: (i) investing in the stock of a savings association; (ii) acquiring a mutual association through the merger of such association into a savings association subsidiary of such holding company or an interim savings association subsidiary of such holding company; (iii) merging with or acquiring another holding company; one of whose subsidiaries is a savings association; (iv) investing in a corporation, the capital stock of which is available for purchase by a savings association under federal law or under the law of any state where the subsidiary savings association or associations share their home offices; (v) furnishing or performing management services for a savings association subsidiary of such company; (vi) holding, managing or liquidating assets owned or acquired from a savings subsidiary of such company; (vii) holding or managing properties used or occupied by a savings association subsidiary of such company properties used or occupied by a savings association subsidiary of such company; (viii) acting as trustee under deeds of trust; (ix) any other activity (A) that the Federal Reserve Board, by regulation, has determined to be permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act of 1956, unless the Director, by regulation, prohibits or limits any such activity for savings and loan holding companies; or (B) in which multiple savings and loan holding companies were authorized (by regulation) to directly engage on March 5, 1987; and (x) purchasing, holding, or disposing of stock acquired in connection with a qualified stock issuance if the purchase of such stock by such savings and loan holding company is approved by the Director. If a mutual holding company acquires or merges with another holding company, the holding company acquired or the holding company resulting from such merger or acquisition may only invest in assets and engage in activities listed in (i) through (x) above, and has a period of two years to cease any non-conforming activities and divest of any non-conforming investments. The HOLA prohibits a savings and loan holding company, including the Stock Company and the Mutual Company, directly or indirectly, or through one or more subsidiaries, from acquiring another savings institution or holding company thereof, without prior written approval of the OTS. It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a non-subsidiary savings institution, a non-subsidiary holding company, or a non-subsidiary company engaged in activities other than those permitted by the HOLA; or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the OTS must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors. The OTS is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies, and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions. Waivers of Dividends by the Mutual Company. OTS regulations require the Mutual Company to notify the OTS of any proposed waiver of its right to receive dividends. It is the OTS' recent practice to review dividend waiver notices on a case-by-case basis, and, in general, not object to any such waiver if: (i) the mutual holding company's board of directors determines that such waiver is consistent with such directors' fiduciary duties to the mutual holding company's members; (ii) for as long as the savings association subsidiary is controlled by the mutual holding company, the dollar amount of dividends waived by the mutual holding company are considered as a restriction on the retained earnings of the savings association, which restriction, if material, is disclosed in the public financial statements of the savings association as a note to the financial statements; (iii) the amount of any dividend waived by the mutual holding company is available for declaration as a dividend solely to the mutual holding company, and, in accordance with SFAS 5, where the savings association determines that the payment of such dividend to the 78 mutual holding company is probable, an appropriate dollar amount is recorded as a liability; (iv) the amount of any waived dividend is considered as having been paid by the savings association in evaluating any proposed dividend under OTS capital distribution regulations; and (v) in the event the mutual holding company converts to stock form, the appraisal submitted to the OTS in connection with the conversion application takes into account the aggregate amount of the dividends waived by the mutual holding company. Conversion of the Mutual Company to Stock Form. OTS regulations and the Plan of Reorganization permit the Mutual Company to convert from the mutual to the capital stock form of organization (a "Conversion Transaction"). There can be no assurance when, if ever, a Conversion Transaction will occur, and the Board of Directors has no current intention or plan to undertake a Conversion Transaction. In a Conversion Transaction a new holding company would be formed as the successor to the Stock Company (the "New Holding Company"), the Mutual Company's corporate existence would end, and certain depositors of the Bank would receive the right to subscribe for additional shares of the New Holding Company. In a Conversion Transaction, each share of common stock held by Minority Stockholders would be automatically converted into a number of shares of common stock of the New Holding Company determined pursuant an exchange ratio that ensures that after the Conversion Transaction, subject to the Dividend Waiver Adjustment described below and a slight adjustment to reflect the receipt of cash in lieu of fractional shares, the percentage of the to-be outstanding shares of the New Holding Company issued to Minority Stockholders in exchange for their common stock would be equal to the percentage of the outstanding shares of common stock held by Minority Stockholders immediately prior to the Conversion Transaction. The total number of shares held by Minority Stockholders after the Conversion Transaction would also be affected by any purchases by such persons in the offering that would be conducted as part of the Conversion Transaction. The Dividend Waiver Adjustment would decrease the percentage of the to-be outstanding shares of common stock of the New Holding Company issued to Minority Stockholders in exchange for their shares of common stock to reflect (i) the aggregate amount of dividends waived by the Mutual Company and (ii) assets other than common stock held by the Mutual Company. Pursuant to the Dividend Waiver Adjustment, the percentage of the to-be outstanding shares of the New Holding Company issued to Minority Stockholders in exchange for their shares of common stock would be equal to the percentage of the outstanding shares of common stock held by Minority Stockholders multiplied by the Dividend Waiver Fraction. The Dividend Waiver Fraction is equal to the product of (a) a fraction, of which the numerator is equal to the Stock Company's stockholders' equity at the time of the Conversion Transaction less the aggregate amount of dividends waived by the Mutual Company and the denominator is equal to the Stock Company's stockholders' equity at the time of the Conversion Transaction, and (b) a fraction, of which the numerator is equal to the appraised pro forma market value of the New Holding Company minus the value of the Mutual Company's assets other than common stock and the denominator is equal to the pro forma market value of the New Holding Company. FEDERAL SECURITIES LAWS The common stock of the Stock Company to be issued in the Offering will be registered with the Securities and Exchange Commission ("SEC") under the Securities Exchange Act of 1934 (the "Exchange Act"). The Stock Company will be subject to the information, proxy solicitation, insider trading restrictions and other requirements of the SEC under the Exchange Act. Company common stock held by persons who are affiliates (generally officers, directors and principal stockholders) of the Stock Company may not be resold without registration or unless sold in accordance with certain resale restrictions. If the Stock Company meets specified current public information requirements, each affiliate of the Stock Company is able to sell in the public market, without registration, a limited number of shares in any three-month period. 79 MANAGEMENT OF THE COMPANY DIRECTORS OF THE STOCK COMPANY Generally. The Board of Directors of the Stock Company will initially consist of the nine persons who are currently directors of the Bank. Directors of the Stock Company will serve three-year staggered terms so that approximately one-third of the Directors will be elected at each annual meeting of stockholders. The class of directors whose term of office expires at the first annual meeting of shareholders following completion of the Reorganization consists of Directors Beal, Fuller, and Massey. The class of directors whose term expires at the second annual meeting of shareholders following completion of the Reorganization consists of Directors Hoyle, Rudisill and Williams. The class of directors whose term of office expires at the third annual meeting of shareholders following the completion of the Reorganization consists of Directors Matthews, Keith and Price. EXECUTIVE OFFICERS OF THE STOCK COMPANY The following individuals will be executive officers of the Stock Company and hold the offices set forth below opposite their names. The biographical information for each executive officer is set forth under "Management of the Bank--Directors and Executive Officers of the Bank." Name Age* Position - ---- ---- -------- Kim S. Price 41 President and Chief Executive Officer Paul L. Teem, Jr. 49 Executive Vice President, Secretary and Chief Operations Officer Gary F. Hoskins 34 Vice President, Treasurer and Chief Financial Officer - --------------------------- *As of September 30, 1997 None of the executive officers has received remuneration from the Stock Company. It is not anticipated that the executive officers of the Stock Company will initially receive any remuneration in his capacity as an executive officer. For information concerning compensation of executive officers of the Bank, see "Management of the Bank." BOARD OF DIRECTORS AND COMMITTEES OF THE STOCK COMPANY AFTER THE REORGANIZATION Following the Reorganization, the Board of Directors of the Stock Company is expected to meet quarterly, or more often as may be necessary. The directors of the Stock Company will not initially receive fees for serving on the Stock Company's Board of Directors. The Board of Directors initially is expected to have, among others, a standing Executive Committee and Audit Committee. The Stock Company's Nominating Committee will comprise the directors serving on the Executive Committee, or the full Board of Directors. The Stock Company does not intend initially to have a compensation committee, as it is not anticipated that the officers of the Stock Company will initially be compensated as such. The Executive Committee initially will consist of Directors Hoyle (who will serve as Chairman), Rudisill, Keith and Price. The Executive Committee is expected to meet as necessary when the Board is not in session to exercise general control and supervision in all matters pertaining to the interests of the Stock Company, subject at all times to the direction of the Board of Directors. 80 The Audit Committee initially will consist of Directors Massey (who will serve as Chairman), Rudisill, Keith, and Beal. The Audit Committee is expected to meet at least quarterly to examine and approve the audit report prepared by the independent auditors of the Bank, to review and recommend the independent auditors to be engaged by the Stock Company, to review the internal accounting controls of the Stock Company, and to review and approve audit policies. MANAGEMENT OF THE BANK DIRECTORS AND EXECUTIVE OFFICERS OF THE BANK Upon completion of the Reorganization, the directors of the Bank will consist of those persons who currently serve on the Board of Directors of the Bank. The directors of the Bank will have three year terms which will be staggered to provide for the election of approximately one-third of the board members each year. Directors of the Bank will be elected by the Stock Company as sole stockholder of the Bank. The directors and executive officers of the Bank as of January 31, 1998 are as follows:
AGE AT CURRENT NAME SEPTEMBER 30, 1997 POSITION (1) DIRECTOR SINCE TERM EXPIRES - ---- ------------------ ------------ -------------- ------------ DIRECTORS:(2) Senator David W. Hoyle 58 Chairman 1975 2000 Ben R. Rudisill, II 54 Vice Chairman 1977 2000 Robert W. Williams, Sr. 69 Vice Chairman 1975 1999 Martha B. Beal 66 Director 1993 1999 James J. Fuller 54 Director 1972 1999 William H. Keith 68 Director 1991 2001 Charles D. Massey 60 Director 1971 1999 Eugene R. Matthews, II 40 Director 1998 2001 Kim S. Price 41 President, Chief Executive 1997 2001 Officer and Director EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS: Paul L. Teem, Jr. 49 Executive Vice President, Secretary and Chief Operations Officer Gary F. Hoskins 34 Vice President, Treasurer and Chief Financial Officer
- ---------- (1) As of January 31, 1998 (2) B. Frank Matthews, II, served as a Director since 1962, most recently as Chairman until his retirement from the Board in January 1998. Mr. Matthews will serve on the Stock Company's Board of Directors. See "Management of the Stock Company" and "Management of the Bank-Compensation of Directors." The business experience for the past five years for each of the Bank's directors and executive officers is as follows: Senator David W. Hoyle has served as a Director of the Bank since 1975. Senator 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. Ben R. Rudisill, II has served as a Director of the Bank since 1977. Mr. Rudisill is the President of Rudisill Enterprises, Inc., a wholesale beverage distributor and has served in that position since 1976. Robert W. Williams, Sr. has served as a Director of the Bank since 1975. Mr. Williams served as President and Chief Executive Officer of Gaston Federal Savings and Loan Association from 1975 to August 1997 and continues to serve as Vice Chairman of the Board of Directors. 81 Martha B. Beal has served as a Director of the Bank since 1993. Mrs. Beal is the Vice President and Financial Officer of Chelsea House, Inc., a manufacturer of decorative arts, accessories and furniture and has served in that position since 1976. James J. Fuller has served as a Director of the Bank since 1972. Mr. Fuller is the President of Mount Holly Furniture Company, Inc., and has served in that position since 1972. William H. Keith has served as a Director of the Bank since 1991. Mr. Keith is retired and was a Senior Vice President and Area Executive for First Union National Bank of North Carolina from 1959 to 1988. Charles D. Massey has served as a Director of the Bank since 1971. Mr. Massey is the Director of Information Services of The Massey Company, Inc., a wholesale industrial distributor and has served in various positions with The Massey Company. Eugene R. Matthews, II was elected to the Bank's Board of Directors in January 1998. Since 1980, Mr. Matthews has been a Senior Vice President and Director of Matthews-Belk Company, a department store chain. Kim S. Price is the President and Chief Executive Officer and a Director of Gaston Federal Savings and Loan Association and has served in that position since August 1997. From 1991 to 1997 Mr. Price served as Vice President for Loan Production for First National Bank of Shelby. Paul L. Teem, Jr. has served as Executive Vice President, Secretary and Chief Operations Officer of the Bank since 1983. Gary F. Hoskins has served as Vice President, Treasurer and Chief Financial Officer of the Bank since August 1997. Prior to that Mr. Hoskins served as a Senior Vice President, Treasurer and Chief Financial Officer of Cherryville Federal Savings and Loan Association from 1995 to 1997. From 1986 to 1995, Mr. Hoskins served as a Thrift Examiner for the Office of Thrift Supervision. MEETINGS OF THE BOARD OF THE BANK The Board of Directors of the Bank meets monthly and may have additional special meetings as may be called by the Chairman or as otherwise provided by law. During the fiscal year ended September, 1997, the Board held 15 meetings. No director attended fewer than 75% in the aggregate of the total number of meetings of the Board or Board Committees on which such Director served during fiscal 1997. COMPENSATION OF DIRECTORS Fees. During the fiscal year ended September 30, 1997, non-employee Directors of the Bank received a retainer fee of $9,150 ($12,750 for the Chairman), plus a fee of $300 per Board meeting attended, $400 per month for serving on the Executive Committee, and $350 per month for other committee meetings. As of October 1, 1997, non-employee Directors of the Bank receive 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. Deferred Compensation and Income Continuation Agreement. In May 1986 we entered into non-qualified deferred compensation agreements ("DCA") for the benefit of Directors Hoyle, Williams, Rudisill, Fuller, Massey and former Director B. Frank Matthews, II. 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 the Bank's year in which the director reaches age 70. In the event of death, 82 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 the Bank. In October 1998, Mr. Matthews will receive the first of what will be 120 monthly payments of $1,026 under the DCA. Supplemental Executive Retirement Plan. In February 1992 the Bank entered into non-qualified supplemental retirement agreements ("SRA") for Directors Keith, Williams, Massey, Hoyle, Fuller, Rudisill, and former Director Matthews. The SRAs directors provide for an annual benefit that ranges from $1,275 to $5,100. Monthly benefits are provided for designated beneficiaries of directors who die before or after age 70 (except as a result of suicide or related injuries therefrom). 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 the Bank. In November 1997 Mr. Matthews received the first of what will be 180 monthly payments of $425 under the SRA. EXECUTIVE COMPENSATION Summary Compensation Table. The following table sets forth for the year ended September 30, 1997, certain information as to the total remuneration paid by the Bank to the persons who served as a Chief Executive Officer of the Bank during any part of the fiscal year ended September 30, 1997, as well as to the four most highly compensated executive officers of the Bank at September 30, 1997, other than the Chief Executive Officer, who received total annual compensation in excess of $100,000 (together, "Named Executive Officers").
ANNUAL COMPENSATION LONG-TERM COMPENSATION -------------------------------------- -------------------------------------------- AWARDS PAYOUTS ------------------- ----------- OTHER YEAR ANNUAL RESTRICTED OPTIONS/ ALL OTHER ENDED COMPENSATION STOCK SARS LTIP COMPENSATION NAME AND PRINCIPAL POSITION SEPTEMBER 30(1) SALARY(2) BONUS(3) (4) AWARDS(5) (#)(6) PAYOUTS (7) - --------------------------- --------------- --------- -------- ------------ ---------- -------- ------- ------------ Kim S. Price (8) 1997 $ 15,000 $ -- -- -- -- -- $ -- Robert W. Williams, Sr. (9) 1997 113,808 11,861 -- -- -- -- 7,470
- --------------- (1) In accordance with the rules on executive officer and director compensation disclosure adopted by the SEC, Summary Compensation information is excluded for the fiscal years ended September 30, 1996 and 1995, as the Bank was not a public company during such periods. (2) Includes compensation deferred at the election of executives pursuant to the 401 (k) plan of the Bank. (3) Includes bonuses deferred at the election of executives pursuant to the 401 (k) plan of the Bank. (4) The 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 persons/benefits is not included in this table. (5) Does not include awards pursuant to the recognition and retention plan, as such awards were not earned, vested or granted in 1997. For a discussion of the terms of the restricted stock plan which is intended to be adopted by the Stock Company, see "--Recognition and Retention Plan." (6) No stock options or SARs were earned or granted in 1997. For a discussion of the stock option plan which is intended to be adopted by the Stock Company, see "--Stock Option Plan." (7) Includes employer contributions to the Bank's 401(K) Plan on behalf of Named Executive Officers. (8) Mr. Price became Chief Executive Officer on August 4, 1997, and the information presented in this table relates to compensation from such date through September 30, 1997. (9) Mr. Williams resigned as Chief Executive Officer and was appointed Vice Chairman in August 1997. EMPLOYMENT AGREEMENTS The Bank intends to enter into an employment agreement with Mr. Price which will provide for a term of thirty-six months. On each anniversary date, the agreement may be extended for an additional twelve months, so that the remaining term shall be thirty-six months. If the agreement is not renewed, the agreement will expire thirty-six months following the anniversary date. The current Base Salary for Mr. Price is $110,000. The Base Salary may be increased but not decreased. In addition to the Base Salary, the agreement provides for, among other things, 83 participation in stock benefit plans and other employee and fringe benefits applicable to executive personnel. The agreement provides for termination by the Bank for cause at any time. In the event the Bank terminates the executive's employment for reasons other than for cause, or in the event of the executive's resignation from the 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 the Bank, or (iv) a breach of the agreement by the 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. The Bank would also continue the executive's life, health, dental and disability coverage for the remaining unexpired term of the agreement. In the event the payments to the executive would include an "excess parachute payment" as defined by Code 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 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 the 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 the Bank. In the event of the executive's disability for a period of six months, the Bank may terminate the agreement provided that the 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 the Bank. In the event of the executive's death, the 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 the 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 HOLA and the rules and regulations thereunder, the non-compete provisions will not apply. DEFINED BENEFIT PENSION PLAN The Bank maintains the Financial Institutions Retirement Fund, which is a qualified, tax-exempt defined benefit plan ("Retirement Plan"). All employees age 20 or older who have worked at the Bank for a period of 5 months are eligible for membership in the Plan for vesting purposes; however, only employees that have been credited with 1,000 or more hours of service with the Bank during the year are eligible to accrue benefits under the Retirement Plan. The Bank annually contributes an amount to the Retirement Plan necessary to satisfy the actuarially determined minimum funding requirements in accordance with the Employee Retirement Income Security Act ("ERISA"). The regular form of all retirement benefits (normal, early or disability) is guaranteed for the life of the retiree, but not less than 120 monthly installments. An optional form of benefit may be selected. These optional forms include various annuity forms as well as a lump sum payment after age 55. Benefits payable upon death may be made in a lump sum, installments over 10 years, or a lifetime annuity. For a married participant, the normal form of benefit is a joint and survivor annuity where, upon the participant's death, the participant's spouse is entitled to receive a benefit equal to 50% of that paid during the participant's lifetime. The normal retirement benefit payable at age 65 with 25 years of service, is an amount equal to 45% of a participant's average compensation based on the average of the five years providing the highest average. A reduced benefit is payable upon retirement at age 65 with less than 25 years of service and at or after completion of five years of service. For the plan year ended June 30, 1997, the Bank made a contribution to the Retirement Plan of $75,700. 84 The following table indicates the annual retirement benefit that would be payable under the Retirement Plan upon retirement at age 65 in calendar year 1997, expressed in the form of a single life annuity for the average salary and benefit service classifications specified below.
High Five-Year Years of Service and Benefit Payable at Retirement Average ----------------------------------------------------------------------------- Compensation 15 20 25 30 35 40 ------------ -------- -------- -------- -------- --------- -------- $50,000 $13,500 $18,000 $22,500 $22,500 $22,500 $22,500 $75,000 $20,300 $27,000 $33,800 $33,800 $33,800 $33,800 $100,000 $27,000 $36,000 $45,000 $45,000 $45,000 $45,000 $125,000 $33,800 $45,000 $56,300 $56,300 $56,300 $56,300 $150,000 $40,500 $54,000 $67,500 $67,500 $67,500 $67,500
As of September 30, 1997, Mr. Robert W. Williams had 22 years of credited service (i.e., benefit service), under the plan. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN The Bank has entered into a non-qualified supplemental retirement agreement ("SRA") with Mr. Robert W. Williams, as an executive of the Bank. The SRA for Mr. Williams provides an annual retirement benefit of $5,249 payable in equal monthly installments over a period of 180 months, commencing on or after age 70. Monthly benefits are provided for Mr. Williams' designated beneficiary(ies) if he dies before or after age 70 (except as a result of suicide or related injuries therefrom). Amounts not paid to Mr. Williams, his beneficiary(ies) or spouse are paid to his estate in a lump sum. Benefits under the SRA are forfeited if Mr. William'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 the Bank. EMPLOYEE STOCK OWNERSHIP PLAN AND TRUST The Bank intends to implement the ESOP in connection with the Reorganization. Employees with at least one year of employment with the Bank and who have attained age 21 are eligible to participate. As part of the Reorganization, the ESOP intends to borrow funds from the Stock Company and use those funds to purchase a number of shares equal to up to 8.0% of the common stock to be sold in the Offering. Collateral for the loan will be the common stock purchased by the ESOP. The loan will be repaid principally from the Bank's discretionary contributions to the ESOP over a period of not less than ten years. It is anticipated that the interest rate for the loan will be a floating rate equal to the Prime Rate. Shares purchased by the ESOP will be held in a suspense account for allocation among participants as the loan is repaid. Contributions to the ESOP and shares released from the suspense account in an amount proportional to the repayment of the ESOP loan will be allocated among ESOP participants on the basis of compensation in the year of allocation. Participants in the ESOP will receive credit for service prior to the effective date of the ESOP. A participant is 100% vested in his benefits after five years or upon normal retirement (as defined in the ESOP), early retirement, disability or death of the participant. A participant who terminates employment for reasons other than death, retirement, or disability prior to five years of credited service will forfeit his benefits under the ESOP. Benefits will be payable in the form of common stock and/or cash upon death, retirement, early retirement, disability or separation from service. The Bank's contributions to the ESOP are discretionary, subject to the loan terms and tax law limits, and, therefore, benefits payable under the ESOP cannot be estimated. Pursuant to SOP 93-6, the Bank is required to record compensation expense in an amount equal to the fair market value of the shares released from the suspense account. 85 In connection with the establishment of the ESOP, the Bank will establish a committee of non-employee directors to administer the ESOP. The Bank will appoint an independent financial institution to serve as trustee of the ESOP. The ESOP trustee, subject to its fiduciary duty, must vote all allocated shares held in the ESOP in accordance with the instructions of participating employees. Under the ESOP, nondirected shares, and shares held in the suspense account, will be voted in a manner calculated to most accurately reflect the instructions it has received from participants regarding the allocated stock so long as such vote is in accordance with the provisions of ERISA. STOCK OPTION PLAN At a meeting of the Stock Company's shareholders to be held no earlier than six months after the completion of the Offering, the Board of Directors intends to submit for shareholder approval a stock option plan for directors and officers of the Bank and of the Stock Company (the "Stock Option Plan"). If approved by the shareholders, common stock in an aggregate amount equal to 10% of the shares sold in the Offering would be reserved for issuance by the Stock Company upon the exercise of the stock options granted under the Stock Option Plan. Ten percent of the shares issued in the Offering would amount to 135,830 shares, 159,800 shares, 183,770 shares or 211,336 shares at the minimum, midpoint, maximum and adjusted maximum of the Offering Range, respectively. No options would be granted under the Stock Option Plan until the date on which shareholder approval is received. It is anticipated that options would be granted for terms of 10 years (in the case of incentive options) or 10 years and one day (in the case of non-qualified options). The exercise price of the options granted under the Stock Option Plan will be equal to the fair market value of the shares on the date of grant of the stock options. If the Stock Option Plan is adopted within one year following the Offering, options will become exercisable at a rate of 20% at the end of each 12 months of service with the Bank after the date of grant, subject to early vesting in the event of death or disability. Options granted under the Stock Option Plan would be adjusted for capital changes such as stock splits and stock dividends. Notwithstanding the foregoing, awards will be 100% vested upon termination of employment due to death or disability, and if the Stock Option Plan is adopted more than 12 months after the Offering, awards would be 100% vested upon normal retirement or a change in control of the Bank or the Stock Company. Under OTS rules, if the Stock Option Plan is adopted within the first 12 months after the Offering, no individual officer can receive more than 25% of the awards under the plan, no outside director can receive more than 5% of the awards under the plan, and all outside directors as a group can receive no more than 30% of the awards under the plan in the aggregate. The Stock Option Plan would be administered by a Committee of non-employee members of the Stock Company's Board of Directors. Options granted under the Stock Option Plan to employees could be "incentive" stock options designed to result in a beneficial tax treatment to the employee but no tax deduction to the Stock Company. Non-qualified stock options could also be granted under the Stock Option Plan, and will be granted to the non-employee directors who receive grants of 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. RECOGNITION AND RETENTION PLAN At a meeting of the Company's shareholders to be held no earlier than six months after the completion of the Offering, the Board of Directors also intends to submit a Recognition and Retention Plan (the "Recognition Plan") for shareholder approval. The Recognition Plan will provide the Bank's directors and officers an ownership interest in the Company in a manner designed to encourage them to continue their service with the Bank. The Bank will contribute funds to the Recognition Plan from time to time to enable it to acquire an aggregate amount of common stock equal to up to 4% of the shares of common stock sold in the Offering, either directly from the Company or in open market purchases. Four percent of the shares issued in the Offering would amount to 54,332 shares, 63,920 shares, 73,508 or 84,534 shares at the minimum, midpoint, maximum and adjusted maximum of the Offering Range, respectively. In the event that additional authorized but unissued shares would be acquired by the Recognition Plan after the Offering, the interests of existing shareholders would be diluted. The executive officers and directors will 86 be awarded common stock under the Recognition Plan without having to pay cash for the shares. No awards under the Recognition Plan would be made until the date the Recognition Plan is approved by the Company's shareholders. Awards under the Recognition Plan would be nontransferable and nonassignable, and during the lifetime of the recipient could only be earned by him. If the Recognition Plan is adopted within one year following the Offering, the shares which are subject to an award would vest and be earned by the recipient at a rate of 20% of the shares awarded at the end of each full 12 months of service with the Bank after the date of grant of the award. Awards would be adjusted for capital changes such as stock dividends and stock splits. Notwithstanding the foregoing, awards would be 100% vested upon termination of employment or service due to death or disability, and if the Recognition Plan is adopted more than 12 months after the Offering, awards would be 100% vested upon normal retirement or a change in control of the Bank or the Company. If employment or service were to terminate for other reasons, the award recipient would forfeit any nonvested award. If employment or service is terminated for cause (as would be defined in the Recognition Plan), shares not already delivered under the Recognition Plan would be forfeited. Under OTS rules, if the Recognition Plan is adopted within the first 12 months after the Offering, no individual officer can receive more than 25% of the awards under the plan, no outside director can receive more than 5% of the awards under the plan, and all outside directors as a group can receive no more than 30% of the awards under the plan in the aggregate. When shares become vested under the Recognition Plan, the participant will recognize income equal to the fair market value of the common stock earned, determined as of the date of vesting, unless the recipient makes an election under ss. 83(b) of the Code to be taxed earlier. The amount of income recognized by the participant would be a deductible expense for tax purposes for the Company. If the Recognition Plan is adopted within one year following the Offering, dividends and other earnings will accrue and be payable to the award recipient when the shares vest. If the Recognition Plan is adopted within one year following the Offering, shares not yet vested under the Recognition Plan will be voted by the trustee of the Recognition Plan, taking into account the best interests of the recipients of the Recognition Plan awards. If the Recognition Plan is adopted more than one year following the Offering, dividends declared on nonvested shares will be distributed to the participant when paid, and the participant will be entitled to vote the nonvested shares. TRANSACTIONS WITH CERTAIN RELATED PERSONS The Bank offers to directors, officers, and employees real estate mortgage loans secured by their principal residence. All loans to the Bank's directors, officers and employees are made on substantially the same terms, including interest rates and collateral as those prevailing at the time for comparable transactions, and do not involve more than minimal risk of collectibility. RESTRICTIONS ON ACQUISITION OF THE COMPANY GENERAL The following discussion is a general summary of certain regulatory restrictions on the acquisition of the common stock. In addition, the following discussion generally summarizes certain provisions of the charter and bylaws of the Stock Company and the Bank and certain regulatory provisions that may be deemed to have an "anti-takeover" effect. THE MUTUAL HOLDING COMPANY STRUCTURE Under OTS regulations, the Plan of Reorganization, and our governing corporate instruments, at least a majority of the Stock Company's voting shares must be owned by the Mutual Company. The Mutual Company will be controlled by its Board of Directors, which will initially consist of persons who are members of the Board of Directors of the Stock Company. The Mutual Company will be able to elect all members of the Board of Directors 87 of the Stock Company, and as a general matter, will be able to control the outcome of all matters presented to the stockholders of the Stock Company for resolution by vote, except for matters that require a vote greater than a majority. The Mutual Company, acting through its Board of Directors, will be able to control the business, and operations of the Stock Company and the Bank, and will be able to prevent any challenge to the ownership or control of the Stock Company by Minority Stockholders. Accordingly, a change in control of the Stock Company and the Bank cannot occur unless the Mutual Company first converts to the stock form of organization. Although OTS regulations and policy and the Plan of Reorganization permit the Mutual Company to convert from the mutual to the capital stock form of organization, it is not anticipated that a conversion of the Mutual Company will occur in the foreseeable future. PROVISIONS OF THE STOCK COMPANY'S CHARTER AND BYLAWS In addition to the anti-takeover aspects of the mutual holding company structure, the following discussion is a general summary of certain provisions of the Stock Company's charter and bylaws and certain other regulatory provisions which will restrict the ability of stockholders to influence management policies, and which may be deemed to have an "anti-takeover" effect. The following description of certain of these provisions is necessarily general and, with respect to provisions contained in the Stock Company's and the Bank's proposed charter and bylaws and the Bank's proposed stock charter and bylaws, reference should be made in each case to the document in question, each of which is part of the Bank's application to the OTS and the Stock Company's Registration Statement filed with the SEC. See "Additional Information." Classified Board of Directors and Related Provisions. The Stock Company's Charter provides that the Board of Directors is to be divided into three classes which shall be as nearly equal in number as possible. The directors in each class hold office for terms of three years and until their successors are elected and qualified. One class is elected annually. Management of the Stock Company believes that the staggered election of directors tends to promote continuity and stability of management but makes it more difficult for stockholders to change a majority of the directors because it generally takes at least two annual elections of directors for this to occur. Absence of Cumulative Voting. The Stock Company's Charter provides that there shall be no cumulative voting rights in the election of directors. Authorization of Preferred Stock. The Stock Company's Charter authorizes shares of serial preferred stock, without par value. The Stock Company is authorized to issue preferred stock from time to time in one or more series subject to applicable provisions of law; and the Board of Directors is authorized to fix the designations, and relative preferences, limitations, voting rights, if any, including without limitation, conversion rights of such shares (which could be multiple or as a separate class). In the event of a proposed merger, tender offer or other attempt to gain control of the Stock Company that the Board of Directors does not approve, it might be possible for the Board of Directors to authorize the issuance of a series of preferred stock with rights and preferences that would impede the completion of such a transaction. An effect of the possible issuance of preferred stock, therefore, may be to deter a future takeover attempt. The Board of Directors has no present plans or understandings for the issuance of any preferred stock but it may issue any preferred stock on terms which the Board deems to be in the best interests of the Stock Company and its stockholders. Restrictions on Acquisitions of Securities. The Stock Company's Charter provides that for a period of five years from the effective date of the charter, no person other than the Mutual Company may directly or indirectly offer to acquire or acquire the beneficial ownership of more than 10% of any class of equity security of the Stock Company. In addition, for a period of five years following the effective date of the Charter each share beneficially owned in violation of the foregoing percentage limitation shall not be counted as shares entitled to vote, shall not be voted by any person or counted as voting shares in connection with any matter submitted to stockholders for a vote, and shall not be counted as outstanding for purposes of determining a quorum or the affirmative vote necessary to approve any matter submitted to the stockholders for a vote. 88 Special Meeting of Stockholders. The Stock Company's Charter provides that for five years after the effective date of the Charter, special meetings of stockholders relating to changes in control of the Stock Company or amendments to the Charter may be called only by the Board of Directors. CHANGE IN BANK CONTROL ACT AND SAVINGS AND LOAN HOLDING COMPANY PROVISIONS OF THE HOLA The Change in Bank Control Act provides that no person, acting directly or indirectly or through or in concert with one or more other persons, may acquire control of a savings and loan holding company unless the OTS has been given 60 days' prior written notice. The Home Owners' Loan Act provides that no company may acquire "control" of a savings and loan holding company without the prior approval of the OTS. Any company that acquires such control becomes a "savings and loan holding company" subject to registration, examination, and regulation by the OTS. Pursuant to federal regulations, control of a savings and loan holding company is conclusively deemed to have been acquired by, among other things, the acquisition of more than 25.0% of any class of voting stock of the institution or the ability to control the election of a majority of the directors of the institution. Moreover, control is presumed to have been acquired, subject to rebuttal, upon the acquisition of more than 10.0% of any class of voting stock, or of more than 25.0% of any class of stock, of a savings and loan holding company, where certain enumerated "control factors" are also present in the acquisition. The OTS may prohibit an acquisition of control if (i) it would result in a monopoly or substantially lessen competition, (ii) the financial condition of the acquiring person might jeopardize the financial stability of the institution, or (iii) the competence, experience, or integrity of the acquiring person indicates that it would not be in the interest of the depositors or of the public to permit the acquisition of control by such person. The foregoing restrictions do not apply to the acquisition of the Stock Company's capital stock by one or more tax-qualified employee stock benefit plans, provided that the plan or plans do not have beneficial ownership in the aggregate of more than 25.0% of any class of equity security of the Stock Company. DESCRIPTION OF CAPITAL STOCK OF THE COMPANY COMPANY CAPITAL STOCK The 30,000,000 shares of capital stock authorized by the Stock Company's Charter are divided into two classes, consisting of 20,000,000 shares of common stock ($1.00 par value) and 10,000,000 shares of serial preferred stock. The aggregate stated value of the issued shares will constitute the capital account of the Stock Company on a consolidated basis. The balance of the Subscription Price of common stock, less expenses of Reorganization and Offering, will be reflected as paid-in capital on a consolidated basis. See "Capitalization." Upon payment of the Subscription Price for the common stock, in accordance with the Plan, all such stock will be duly authorized, fully paid, validly issued and nonassessable. Common Stock. Each share of the Common Stock will have the same relative rights and will be identical in all respects with each other share of the Common Stock. The Common Stock of the Stock Company will represent non-withdrawable capital, will not be of an insurable type and will not be insured by the FDIC. The holders of the Common Stock will possess exclusive voting power in the Stock Company. Each stockholder will be entitled to one vote for each share held on all matters voted upon by stockholders, subject to the limitation discussed under "Restrictions on Acquisitions of the Stock Company--Provisions of the Stock Company's Charter and Bylaws." If the Stock Company issues preferred stock subsequent to the Reorganization, holders of the preferred stock may also possess voting powers. No Preemptive Rights. Holders of the Common Stock will not be entitled to preemptive rights with respect to any shares which may be issued. The Common Stock will not be subject to call for redemption, and, upon receipt by the Stock Company of the full purchase price therefor, each share of the common stock will be fully paid and nonassessable. 89 Preferred Stock. After the Reorganization, the Board of Directors of the Stock Company will be authorized to issue preferred stock in series and to fix and state the voting powers, designations, preferences and relative, participating, optional or other special rights of the shares of each such series and the qualifications, limitations and restrictions thereof. Preferred stock may rank prior to the common stock as to dividend rights, liquidation preferences, or both, and may have full or limited voting rights. The holders of preferred stock will be entitled to vote as a separate class or series under certain circumstances, regardless of any other voting rights which such holders may have. Except as discussed herein, the Stock Company has no present plans for the issuance of the additional authorized shares of common stock or for the issuance of any shares of preferred stock. In the future, the authorized but unissued and unreserved shares of common stock will be available for general corporate purposes including but not limited to possible issuance as stock dividends or stock splits, in future mergers or acquisitions, under a cash dividend reinvestment and stock purchase plan, in a future underwritten or other public offering or under an employee stock ownership plan, stock option or restricted stock plan. The authorized but unissued shares of preferred stock will similarly be available for issuance in future mergers or acquisitions, in a future underwritten public offering or private placement or for other general corporate purposes. Except as described above or as otherwise required to approve the transaction in which the additional authorized shares of common stock or authorized shares of preferred stock would be issued, no stockholder approval will be required for the issuance of these shares. Accordingly, the Board of Directors of the Stock Company, without stockholder approval, can issue preferred stock with voting and conversion rights which could adversely affect the voting power of the holders of common stock. Dividends. Upon consummation of the formation of the Stock Company, the Stock Company's only asset will be the Bank's common stock and $100,000. Although it is anticipated that the Stock Company will retain up to 50% of the net proceeds of the Offering, dividends from the Bank will be an important source of income for the Stock Company. Should the Bank elect to retain its income, the ability of the Stock Company to pay dividends to its own shareholders may be adversely affected. Furthermore, if at any time in the future the Stock Company owns less than 100% of the outstanding stock of the Bank, certain tax benefits under the Code as to inter-company distributions will not be fully available to the Stock Company and it will be required to pay federal income tax on a portion of the dividends received from the Bank, thereby reducing the amount of income available for distribution to the shareholders of the Stock Company. TRANSFER AGENT AND REGISTRAR ChaseMellon Shareholder Services will act as the transfer agent and registrar for the common stock. LEGAL AND TAX MATTERS The legality of the common stock and the federal income tax consequences of the Offering will be passed upon for the Bank and the Stock Company by the firm of Luse Lehman Gorman Pomerenk & Schick, P.C., Washington, D.C. Luse Lehman Gorman Pomerenk & Schick, P.C . has consented to the references herein to their opinions. Certain legal matters relating to the Offering may be passed upon for Trident Securities by Womble Carlyle Sandbridge & Rice PLLC., Atlanta, Georgia. EXPERTS The financial statements as of September 30, 1997 and 1996 and for the years then ended included in this Prospectus 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 upon their authority as experts in accounting and auditing. On August 18, 1997, Butler & Stowe, the independent accountants who were previously engaged as principal accountant to audit the Bank's financial statements resigned, and the Bank retained Cherry, Bekaert & Holland, L.L.P., independent auditors. The change in accountants was approved by the Bank's 90 Board of Directors. The prior accountant's report on the financial statements as of and for the fiscal year ended September 30, 1996, did not contain an adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope, or accounting principles. During the Bank's two most recent fiscal years preceding such resignation there were no disagreements with the former accountant on any matter of accounting principles or practices, financial statement disclosure, or auditing scope of procedure, nor were there any other events that require reporting under SEC regulations. Feldman Financial has consented to the publication herein of the summary of its report to the Bank and the Stock Company setting forth its opinion as to the estimated pro forma market value of the common stock upon Reorganization and its valuation with respect to Subscription Rights. ADDITIONAL INFORMATION The Stock Company has filed with the SEC a registration statement under the Securities Act, with respect to the common stock offered hereby. As permitted by the rules and regulations of the SEC, this Prospectus does not contain all the information set forth in the registration statement. Such information can be examined without charge at the public reference facilities of the SEC located at 450 Fifth Street, NW, Washington, D.C. 20549, and copies of such material can be obtained from the SEC at prescribed rates. The SEC maintains a web site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The address of this web site is http://www.sec.gov. The statements contained herein as to the contents of any contract or other document filed as an exhibit to the registration statement are, of necessity, brief descriptions thereof and are not necessarily complete but do contain all material information regarding such documents; each such statement is qualified by reference to such contract or document. In connection with the Offering, the Stock Company will register the common stock with the SEC under Section 12(g) of the Exchange Act; and, upon such registration, the Stock Company and the holders of its common 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 Exchange Act. Under the Plan, the Stock Company has undertaken that it will not terminate such registration for a period of at least three years following the Reorganization. A copy of the certificate of incorporation and bylaws of the Stock Company are available without charge from the Bank. 91 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION AND SUBSIDIARY Financial Statements for the years ended September 30, 1997 and 1996 Contents Page Report of Independent Auditors F-1 Consolidated Statements of Condition F-2 Consolidation Statements of Operations 41 Consolidation Statements of Changes in Equity F-3 Consolidated Statements of Cash Flows F-4 Notes to Consolidated Financial Statements F-5 - F-14 Certain schedules required by OTS regulations and by Regulation S-X are not included because they are not applicable or the required information has been disclosed elsewhere. Financial statement related to Gaston Federal Bancorp, Inc. and Gaston Federal Holdings, MHC are not included as they have not begun operations. [CHERRY BEKAERT & HOLLAND LOGO APPEARS HERE] REPORT OF INDEPENDENT AUDITORS The Board of Directors Gaston Federal Savings & Loan Association We have audited the accompanying consolidated statements of condition of Gaston Federal Savings & Loan Association and subsidiary as of September 30, 1997 and 1996 and the related consolidated statements of operations, changes in equity and cash flows for the years then ended. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Gaston Federal Savings & Loan Association and subsidiary as of September 30, 1997 and 1996 and the results of their operations and their cash flows for the years then ended, in conformity with generally accepted accounting principles. /s/ Cherry, Bekaert & Holland, L.L.P. Gastonia, North Carolina October 24, 1997 F-1 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION and SUBSIDIARY Consolidated Statements of Condition
September 30 1997 1996 ------------ ------------ Assets Cash and due from banks $ 2,422,301 $ 1,655,234 Interest-earning bank balances 2,203,314 508,340 ------------ ------------ Cash and cash equivalents 4,625,615 2,163,574 Investment securities Available-for-sale 8,248,173 5,514,971 Held-to-maturity (fair value $10,425,353 in 1997 and $14,663,381 in 1996) 10,407,029 14,751,246 Mortgage-backed securities held-to-maturity (fair value $10,193,711 in 1997 and $12,845,548 in 1996) 10,087,081 12,917,935 Loans, net 134,491,057 130,862,457 Premises and equipment 2,139,497 2,327,160 Accrued interest receivable 981,313 995,402 Federal Home Loan Bank stock 1,276,000 1,261,100 Other assets 1,214,683 1,158,975 ------------ ------------ Total assets $173,470,448 $171,952,820 ============ ============ Liabilities and Equity Deposits $145,443,500 $145,975,092 Advances from borrowers for taxes and insurance 1,042,360 791,223 Accrued interest payable 412,234 407,567 Advances from Federal Home Loan Bank 3,500,000 3,750,000 Deferred income taxes 424,000 182,850 Other liabilities 1,780,358 1,762,409 ------------ ------------ Total liabilities 152,602,452 152,869,141 Commitments and contingencies Equity Retained earnings (substantially restricted) 19,769,045 18,337,197 Unrealized gain on securities available-for-sale, net of tax 1,098,951 746,482 ------------ ------------ Total equity 20,867,996 19,083,679 ------------ ------------ Total liabilities and equity $173,470,448 $171,952,820 ============ ============
See notes to consolidated financial statements. F-2 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION and SUBSIDIARY Consolidated Statements of Changes in Equity
Unrealized Gain (Loss) on Securities Retained Available for Total Earnings Sale, net Equity ----------- -------------------- ----------- Balance September 30, 1995 $17,836,949 $ 568,776 $18,395,725 Net income 510,248 510,248 Unrealized gain on securities available-for-sale, net of tax 177,706 177,706 ----------- ---------- ----------- Balance September 30, 1996 18,337,197 746,482 19,083,679 Net income 1,431,848 1,431,848 Unrealized gain on securities available-for-sale, net of tax 352,469 352,469 ----------- ---------- ----------- Balance September 30, 1997 $19,769,045 $1,098,951 $20,867,996 =========== ========== ===========
See notes to consolidated financial statements. F-3 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION and SUBSIDIARY Consolidated Statements of Cash Flows
Year Ended September 30 1997 1996 ----------- ------------ Operating Activities Net income $ 1,431,848 $ 510,248 Adjustments to reconcile net income to net cash provided by operating activities Provision for loan losses 292,652 47,198 Depreciation 280,879 314,157 Deferred income tax expense (benefit) 12,000 (316,500) Gain on sale of investments available-for-sale (52,261) - Gain on sale of equipment (4,059) (22,062) Gain on sale of real estate owned (90,604) (8,263) Deferred loan origination fees (5,754) 104,627 (Increase) decrease in interest receivable 14,089 (19,937) Increase in prepaid expenses (256,326) (121,282) Increase (decrease) in accounts payable (325,772) 900,769 Increase (decrease) in accrued interest payable 4,667 (40,268) Increase (decrease) in accrued income taxes 575,107 (197,387) ----------- ------------ Net cash provided by operating activities 1,876,466 1,151,300 Investing Activities Net increase in loans made to customers (3,915,498) (11,624,419) Sales of investments available-for-sale 601,210 - Maturities and prepayments of investments held-to-maturity 9,100,000 8,750,000 Maturities and prepayments of mortgage-backed securities 2,830,854 3,199,342 Purchases of investments available-for-sale (2,742,786) (242,002) Purchases of investments held-to-maturity (4,755,783) (5,348,750) Purchases of mortgage-backed securities - (4,127,458) Purchase of FHLB stock (14,900) - Purchases of premises and equipment (103,157) (203,745) Proceeds from sales of premises and equipment 14,900 29,025 Proceeds from sales of real estate owned 102,090 164,690 ----------- ------------ Net cash provided by (used for) investing activities 1,116,030 (9,403,317) Financing Activities Net increase (decrease) in deposits (531,592) 4,543,449 Advances from FHLB 8,000,000 8,900,000 Repayment of advances from FHLB (8,250,000) (7,150,000) Increase (decrease) in advances from borrowers for insurance and taxes 251,137 (109,178) ----------- ------------ Net cash provided by (used for) financing activities (530,455) 6,184,271 ----------- ------------ Net increase (decrease in cash and cash equivalents 2,462,041 (2,067,746) Cash and cash equivalents at beginning of year 2,163,574 4,231,320 ----------- ------------ Cash and cash equivalents at end of year $ 4,625,615 $ 2,163,574 =========== ============
See notes to consolidated financial statements. F-4 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION and SUBSIDIARY Notes to Consolidated Financial Statements Note 1 - Summary of Significant Accounting Policies The accounting and reporting policies of Gaston Federal Savings & Loan Association and its subsidiary follow generally accepted accounting principles 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 Gaston Federal Savings & Loan Association (Gaston Federal) and its wholly-owned subsidiary, Gaston Financial Services, Inc. Gaston Financial Services, Inc. acts as an independent agent selling various financial products. All significant intercompany accounts and transactions have been eliminated. Use of Estimates - The financial statements are prepared in accordance with generally accepted accounting principles 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 - Gaston Federal 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, as cash and cash equivalents. Securities - Management determines the appropriate classification of securities at the time of purchase. Securities are classified as held-to-maturity when Gaston Federal has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Securities classified as available-for-sale are carried at fair value. Such securities are used to execute asset/liability management and to manage liquidity. Adjustments for unrealized gains or losses, net of related income tax effect, are reported as a separate component of equity. Gaston Federal has no trading portfolio. 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 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 potential losses 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 - Gaston Federal makes loans to individuals and small businesses primarily in Gaston County, North Carolina and surrounding counties. Gaston Federal has a diversified loan portfolio, and the borrowers' ability to repay their loans is not dependent upon any specific economic segment. F-5 Note 1 - Summary of Significant Accounting Policies (continued) 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. Other Real Estate Owned - Other real estate owned, included in other assets, 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. Advertising - Advertising costs are expensed as incurred. Reclassifications - Certain of the prior year amounts have been reclassified or restated to conform to current year presentation; such reclassifications and restatements are immaterial to the financial statements. Note 2 - Investment Securities The aggregate book and fair values, as well as gross unrealized gains and losses, of investment securities as of September 30 were as follows:
September 30, 1997 ------------------------------------------------------- Book Unrealized Unrealized Fair Value Gains Losses Value ------------------------------------------------------- Available-for-Sale - ------------------ Federated Government Trust $ 3,036,073 $ 227,513 $ - $ 3,263,586 US League Asset Mgmt Fund 1,375,086 14,490 - 1,389,576 FHLMC Stock 43,967 1,541,533 - 1,585,500 US Treasury and other agencies 1,987,935 21,576 - 2,009,511 ----------- ---------- -------- ----------- Total Available-for-sale $ 6,443,061 $1,805,112 $ - $ 8,248,173 =========== ========== ======== =========== Held-to-Maturity - ---------------- US Treasury and other agencies $10,407,029 $ 24,100 $ (5,776) $10,425,353 =========== ========== ======== =========== Mortgage-backed securities Held-to-Maturity - ------------------------------------------- FHLMC $ 5,238,150 $ 112,845 $(18,967) $ 5,332,028 FNMA 3,588,454 4,131 (22,176) 3,570,409 GNMA 1,260,477 33,322 (2,525) 1,291,274 ----------- ---------- -------- ----------- Total mortgage-backed securities $10,087,081 $ 150,298 $(43,668) $10,193,711 =========== ========== ======== ===========
F-6 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION and SUBSIDIARY Notes to Consolidated Financial Statements (continued) Note 2 - Investment Securities (continued)
September 30, 1996 ----------------------------------------------------------- Book Unrealized Unrealized Fair Value Gains Losses Value ----------------------------------------------------------- Available-for-Sale - ------------------ Federated Government Trust $ 2,861,317 $ 182,335 $ - $ 3,043,652 US League Asset Mgmt Fund 1,294,464 9,868 - 1,304,332 FHLMC Stock 43,969 1,073,018 - 1,116,987 Other 50,000 - - 50,000 ------------ ------------ ------------ ------------ Total Available-for-sale $ 4,249,750 $ 1,265,221 $ - $ 5,514,971 ============ ============ ============ ============ Held-to-Maturity - ---------------- US Treasury and other agencies $ 14,751,246 $ 4,554 $ (92,419) $ 14,663,381 ============ ============ ============ ============ Mortgage-backed securities Held-to-Maturity - ------------------------------------------- FHLMC $ 6,812,992 $ 48,019 $ (32,544) $ 6,828,467 FNMA 4,662,651 16,493 (111,303) 4,567,841 GNMA 1,442,292 21,641 (14,693) 1,449,240 ------------ ------------ ------------ ------------ Total mortgage-backed securities $ 12,917,935 $ 86,153 $ (158,540) $ 12,845,548 ============ ============ ============ ============
The mutual fund investments are in funds that invest primarily in obligations of the US government or its agencies. The book value and estimated fair value of debt securities at September 30, 1997, 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. September 30, 1997 ---------------------------- Book Fair Value Value ---------------------------- Available-for-Sale - ------------------ Due after one year through five years $ 1,987,935 $ 2,009,511 ------------- ------------- Mutual funds 4,411,159 4,653,162 Equity securities 43,967 1,585,500 ------------- ------------- $ 6,443,061 $ 8,248,173 ============= ============= Held-to-maturity - ---------------- Due in one year or less $ 2,048,362 $ 2,050,574 Due after one year through five years 8,110,396 8,126,302 Due after five years through ten years - - Due after ten years 248,271 248,477 ------------- ------------- $ 10,407,029 $ 10,425,353 ============= ============= Mortgage-backed securities $ 10,087,081 $ 10,193,711 ============= ============= F-7 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION and SUBSIDIARY Notes to Consolidated Financial Statements (continued) Note 3 - Loans and Allowance for Loan Losses The following is a summary of loans outstanding by category at September 30: 1997 1996 ------------------------------ Real estate: One-to-four family residential $106,422,243 $104,363,477 Multi-family residential 6,514,000 6,843,000 Commercial mortgage 7,318,055 6,458,000 Construction 5,868,907 6,826,964 Commercial 5,558,332 5,160,086 Consumer 7,429,841 6,378,866 -------------- -------------- Gross loans 139,111,378 136,030,393 Less: Loans in process 2,989,750 3,811,611 Deferred loan fees, net 520,571 526,325 Allowance for loan losses 1,110,000 830,000 -------------- -------------- Net loans $ 134,491,057 $ 130,862,457 ============== ============== Gaston Federal 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 September 30, 1997 and 1996 were immaterial. The following information relates to all loans which had been placed on nonaccrual at September 30: 1997 1996 ------------------------- Nonaccrual loans $ 1,059,000 $ 1,194,000 Interest income that would have been recognized if loans had been current 41,649 46,101 Interest income recognized on cash basis 0 0 Changes in the allowance for loan losses for the two years ended September 30, 1997 were as follows: 1997 1996 ------------------------- Balance at beginning of year $ 830,000 $ 786,000 Provision for loan losses 292,652 47,198 Recoveries on loans previously charged off - - Loans charged off (12,652) (3,198) ------------ --------- Balance at end of year $ 1,110,000 $ 830,000 ============ ========= Directors, executive officers, and associates of such persons were customers of and had transactions with Gaston Federal 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 was $760,128 and $831,130 at September 30, 1997 and 1996, respectively. During 1997, new loans of $71,632 were made and payments totaled $142,634. F-8 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION and SUBSIDIARY Notes to Consolidated Financial Statements (continued) Note 4 - Premises and Equipment Premises and equipment at September 30 are summarized as follows: 1997 1996 ------------------------- Land $ 604,704 $ 604,704 Buildings 1,650,767 1,652,429 Land improvements 99,738 103,226 Furniture and equipment 1,681,655 2,302,442 ----------- ----------- 4,036,864 4,662,801 Less accumulated depreciation 1,897,367 2,335,641 ----------- ----------- $ 2,139,497 $ 2,327,160 =========== =========== Note 5 - Deposits Deposit balances as of September 30 and average rates paid for the years then ended are summarized as follows:
1997 1996 ------------------------------------- -------------------------------------- Balance Interest Paid Rate Balance Interest Paid Rate ------------- ------------- ---- ------------- ------------- ----- Noninterest-bearing demand $ 3,022,611 - - $ 2,087,904 - - Interest-bearing demand 25,906,245 $ 672,000 2.8% 23,715,813 $ 685,000 2.9% Passbook savings 14,196,836 387,000 2.8% 14,082,235 394,000 2.9% Savings certificates 102,317,808 5,746,000 5.5% 106,089,140 6,215,000 5.8% ------------- ---------- ------------- ---------- $ 145,443,500 $6,805,000 4.6% $ 145,975,092 $7,294,000 5.0% ============= ========== === ============= ========== ===
Contractual maturities of savings certificates as of September 30, 1997 are as follows: Under 1 year $ 87,758,157 1 to 2 years 10,680,176 2 to 3 years 3,879,475 ------------- $ 102,317,808 ============= Certificates of deposit in excess of $100,000 totaled $17,611,000 and $17,465,000 at September 30, 1997 and 1996, respectively, and are not federally insured. Interest paid on deposits and other borrowings was $6,947,207 and $7,397,775 for the years ended September 30, 1997 and 1996, respectively. Note 6 - 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 5.66% to 6.69% at September 30, 1997 and 6.05% to 6.69% at September 30, 1996. The unused portion of the line of credit available to Gaston Federal at September 30, 1997 was $18,500,000. F-9 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION and SUBSIDIARY Notes to Consolidated Financial Statements (continued) Note 6 - Advances from the Federal Home Loan Bank (continued) Maturities of advances at September 30 are as follows: 1997 1996 ------------------------ Advances from FHLB due: Less than 1 year $ 1,500,000 $ 2,250,000 1 to 2 years - 1,500,000 2 to 3 years - - 3 to 4 years - - 4 to 5 years 2,000,000 - ----------- ----------- $ 3,500,000 $ 3,750,000 =========== =========== Note 7 - Income Taxes The provision for income taxes is summarized below: 1997 1996 ----------------------- Currently payable Federal $ 728,000 $ 567,900 State 79,000 99,800 ---------- ----------- 807,000 667,700 Deferred Federal 10,000 (241,500) State 2,000 (75,000) ---------- ----------- 12,000 (316,500) ---------- ----------- Total income taxes $ 819,000 $ 351,200 ========== =========== 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: 1997 1996 ---------------------- Federal income taxes at statutory rate $ 765,000 $ 292,900 State income taxes, net of federal benefit 53,000 16,400 Other 1,000 41,900 ---------- ---------- $ 819,000 $ 351,200 ========== ========== Effective tax rate 36.4% 40.8% ========== ========== Income taxes recoverable (payable) are included in other assets (liabilities) and were $(385,975) and $182,850, at September 30, 1997 and 1996, respectively. Income taxes paid for the years ended September 30, 1997 and 1996 were $296,753 and $747,554, respectively. The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at September 30 are as follows: F-10 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION and SUBSIDIARY Notes to Consolidated Financial Statements (continued) Note 7 - Income Taxes (continued) 1997 1996 --------------------------- Deferred tax assets Deferred compensation $ 188,000 $ 151,000 Deferred loan fees 207,000 206,000 SAIF premium - 339,000 Other 91,000 20,000 ------------ ------------ Gross deferred tax assets 486,000 716,000 Deferred tax liabilities Allowance for loan losses 25,000 227,100 Unrealized gain on securities available-for-sale 706,000 518,739 Depreciation 47,000 63,200 Other 132,000 89,811 ------------ ------------ Gross deferred tax liabilities 910,000 898,850 ------------ ------------ Net deferred tax liability $ (424,000) $ (182,850) ============ ============ Gaston Federal, in accordance with SFAS No. 109, has not recorded a deferred tax liability of approximately $1,870,000 as of September 30, 1997 related to the cumulative special bad debt deduction for savings and loan associations recognized for income tax reporting prior to September 30, 1988, Gaston Federal's base year. Management believes that Gaston Federal will fully realize deferred tax assets based on future taxable temporary differences, refundable income taxes from carryback years, and current levels of operating income. Note 8 - 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 as of September 30 are as follows: 1997 1996 -------------------------- Loan commitments $ 5,047,000 $ 1,369,000 Unused lines of credit Commercial 2,418,000 2,476,000 Consumer 7,131,000 6,429,000 Loan commitments at September 30, 1997 include $1.6 million with fixed rates ranging from 6.75% to 8.0%, and $3.4 million at variable rates based on the prime rate or on the US treasury bill rates. Commitment periods are typically 60 days. F-11 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION and SUBSIDIARY Notes to Consolidated Financial Statements (continued) Note 9 - Regulatory Capital Requirements Gaston Federal 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, Gaston Federal 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 Gaston Federal's financial statements. Gaston Federal is required to maintain: tangible capital of at least 1.5% of adjusted total assets; core capital of at least 3.0% of adjusted total assets; and total capital of at least 8.0% of risk weighted assets. At September 30, 1997, Gaston Federal's tangible capital and core capital were both $19,890,045, or 11.5% of tangible assets, and total capital was $20,800,000, or 21.4% of risk-weighted assets. Regulators informed Gaston Federal that it was in the well-capitalized category as of the most recent regulatory examinations, and management is not aware of any events that have occurred since that would have changed its classification. The following is a reconciliation of equity as reported in accordance with generally accepted accounting principles to federal regulatory capital, and related capital ratios:
1997 1996 -------------------------------------------------------- Amount Ratio Amount Ratio -------------------------------------------------------- Retained earnings per financial statements $ 19,769,045 $ 18,337,197 Adjustments Income taxes - (280,818) Other 121,000 (38,379) ------------- ------------ ------------- ----------- Tangible capital (to total adjusted assets) $ 19,890,045 11.5% $ 18,018,000 10.4% ============= ============ ============= =========== Core Capital (to total adjusted assets) $ 19,890,045 11.5% $ 18,018,000 10.4% ============= ============ ============= =========== Plus qualified allowance for loan losses $ 910,000 830,000 ------------- ------------- Risk-based capital (to risk weighted assets) $ 20,800,045 21.4% $ 18,848,000 22.3% ============= ============ ============= ===========
The deposits of Gaston Federal are insured by the Savings Association Insurance Fund (SAIF), one of two funds administered by the FDIC. Gaston Federal previously paid annual premiums of approximately $.23 per $100 of deposits. On September 30, 1996, the Deposit Insurance Funds Act of 1996 was signed, which authorized the FDIC to impose a special assessment on certain deposits held by thrift institutions. This special assessment, which was based on $.657 per $100 of outstanding deposits at March 31, 1995, was intended to recapitalize the SAIF. Accordingly, Gaston Federal recorded a one time pre-tax charge of approximately $867,000 at September 30, 1996, which was paid prior to December 31, 1996. Gaston Federal's annual SAIF premium rates were reduced to $.0648 per $100 of deposits beginning January 1, 1997. F-12 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION and SUBSIDIARY Notes to Consolidated Financial Statements (continued) Note 10 - Employee Benefit Plans Gaston Federal contributes to the Financial Institutions Retirement Fund, a multiemployer, qualified, noncontributory defined benefit pension plan that covers substantially all employees meeting age and service requirements. The plan provides pension benefits based on the employee's length of credited service and final average compensation as defined in the plan. The plan requires employers to fund amounts necessary to meet ERISA minimum funding requirements. Total expense relating to this plan was $75,693 in 1997 and $66,233 in 1996. Separate company information relating to Gaston Federal is not available. Gaston Federal also provides supplemental benefits to substantially all employees through a 401(k) savings plan. Eligible participants may contribute up to 15% of base salary, with Gaston Federal providing matching contributions of 25% of employee contributions. The plan also provides for discretionary employer contributions. Total expense relating to this plan was $123,443 in 1997 and $99,876 in 1996. Gaston Federal also maintains nonqualified deferred compensation and supplemental retirement plans for its directors. Total expense for the plans were $64,260 in 1997 and $60,888 in 1996. The accrued liabilities for the plans were $480,000 and $441,900 at September 30, 1997 and 1996, respectively. Note 11 - Other expenses Other expenses in the statements of operations relate primarily to miscellaneous operating expenses, such as postage and office supplies, and charitable contributions. Note 12 - Fair Value of Financial Instruments The following methods and assumptions were used by Gaston Federal 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 values for investment securities and mortgage-backed 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. Fair values for the advances from the Federal Home Loan Bank Board is based on discounted cash flows using current interest rates. At September 30, 1997 and 1996, Gaston Federal 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 September 30, 1997 and 1996, the carrying amounts and fair values of these off-balance sheet financial instruments were immaterial. F-13 GASTON FEDERAL SAVINGS & LOAN ASSOCIATION and SUBSIDIARY Notes to Consolidated Financial Statements (continued) Note 12 - Fair Value of Financial Instruments (continued) Gaston Federal 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 Gaston Federal. The estimated fair values of financial instruments as of September 30 were as follows:
1997 1996 -------------------------------------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value -------------------------------------------------------- Financial assets Cash and due from banks $ 2,422,301 $ 2,422,301 $ 1,655,234 $ 1,655,234 Interest-earning bank balances 2,203,314 2,203,314 508,340 508,340 Investment and mortgage- backed securities 28,742,283 28,867,237 33,184,152 33,023,900 Loans 134,491,057 135,227,000 130,862,457 130,455,000 Financial liabilities Deposits 145,443,500 145,287,000 145,975,092 145,931,000 Advances from FHLB 3,500,000 3,421,000 3,750,000 3,748,000
Note 13 - Adoption of Plan of Conversion On July 14, 1997, the Board of Directors of Gaston Federal adopted the Plan of Reorganization From Mutual Savings Association to Mutual Holding Company and Stock Issuance Plan (the Plan), pursuant to which Gaston Federal will convert from a federally chartered mutual savings and loan association to a federally chartered stock savings bank, all of the outstanding common stock of which will be acquired by a holding company formed expressly for such purpose, in exchange for a portion of the net conversion proceeds (Conversion). All of the common stock of the Company to be issued in the Conversion is being offered initially to certain eligible account holders, members and to certain of Gaston Federal's tax-qualified employee benefit plans. A mutual holding company will be formed and will own approximately 51% of the stock holding company. The retained earnings of Gaston Federal will be substantially restricted after the reorganization by OTS regulations limiting capital distributions. Following the Conversion, the bank may not pay a dividend or make a capital distribution that would cause the bank to fall below its minimum capital guidelines. Costs incurred in the reorganization, which were immaterial at September 30, 1997, will be offset against proceeds if the conversion is completed as planned, or charged to expense in the event the reorganization is not completed. Gaston Federal plans to establish an Employee Stock Ownership Plan (ESOP) for the benefit of eligible employees, to become effective upon consummation of the Conversion. The ESOP intends to purchase up to 8% of the Company's common stock issued in the Conversion utilizing the proceeds of a loan from the Company. The loan will be repaid over a period of 10 years and the collateral for the loan will be the common stock purchased by the ESOP. F-14 GLOSSARY 1933 Act Securities Act of 1933, as amended 1934 Act Securities Exchange Act of 1934, as amended Associate The term "Associate" of a person is defined to mean the following: (i) any corporation or organization (other than the Bank or its subsidiaries or the Company) of which such person is a director, officer, partner or 10% shareholder; (ii) any trust or other estate in which such person has a substantial beneficial interest or serves as trustee or in a similar fiduciary capacity; provided, however that such term shall not include any employee stock benefit plan of the Stock Company or the Bank in which such a person has a substantial beneficial interest or as a trustee or in a similar fiduciary capacity; and (iii) any relative or spouse of such person, or relative of such spouse, who either has the same home as such person or who is a director or officer of the Bank or its subsidiaries or the Stock Company Bank Gaston Federal Savings and Loan Association prior to completion of the Reorganization, or Gaston Federal Bank after the conclusion of the Reorganization, as indicated by the context. BIF Bank Insurance Fund of the FDIC Code The Internal Revenue Code of 1986, as amended Community Offering Offering for sale to members of the general public of shares of common stock not subscribed for in the Subscription Offering, with preference given to natural persons residing in Gaston County, North Carolina. Common Stock Common Stock, par value of $1.00 per share, of Gaston Federal Bancorp, Inc. Company Gaston Federal Bancorp, Inc., the parent holding company for Gaston Federal Bank, and the issuer of the shares of Common Stock in the Offering Eligible Account Holders Holders of deposit accounts with the Bank with account balances of at least $50 as of the close of business on March 31, 1996 ERISA Employee Retirement Income Security Act of 1974, as amended ESOP The Gaston Federal Bancorp, Inc. Employee Stock Ownership Plan and Trust Estimated Valuation Range Estimated pro forma market value of the Stock Company's Common Stock to be issued in the Reorganization, or $28,900,000 to $39,100,000. The maximum of the Estimated Valuation Range may be increased to $44,965,000 without a resolicitation of subscribers Expiration Date 12:00 noon, local time, on March ___, 1998 FASB Financial Accounting Standards Board G-1 FDIC Federal Deposit Insurance Corporation FDICIA Federal Deposit Insurance Corporation Improvement Act of 1991, as amended FNMA Federal National Mortgage Association Independent Valuation The appraisal of the pro forma market value of the Stock Company's Common Stock to be issued in the Reorganization, as determined by Feldman Financial Advisors, Inc. Washington, D.C. IRA Individual retirement account or arrangement IRS Internal Revenue Service Minority Shares The shares of Common Stock sold to the depositors and the public in the Offering pursuant to the Prospectus, which will represent, in the aggregate, a minority ownership position in the Stock Company MMDA Money Market Demand Account Mutual Company Gaston Federal Holdings, MHC, a federal mutual holding company, which will own, and which by law must own, a majority of the shares of Common Stock of the Stock Company NASD National Association of Securities Dealers, Inc. NOW account Negotiable Order of Withdrawal Account NPV Net portfolio value Offering The offer and sale of Common Stock to depositors and the public pursuant to the Prospectus Offering Range The offer and sale by the Stock Company of between 1,358,300 and 2,113,355 shares (subject to adjustment to 4,496,500 shares) of Common Stock pursuant to the Prospectus Order Form Form for ordering stock accompanied by a certification concerning certain matters Plan Reorganization Gaston Federal Savings and Loan Association Plan of Reorganization from a Mutual Savings Association to a Mutual Company and Stock Issuance Plan Reorganization The reorganization of the Bank from the mutual to the stock form of organization, the organization of the Stock Company, the issuance of all of the Bank's common stock to the Stock Company, the issuance of a majority of the Stock Company's Common Stock to the Mutual Company, and the offer and sale of the Minority Shares to depositors and the public pursuant to the Prospectus REO Real Estate Owned G-2 Recognition and Retention Plan The Recognition and Retention Plan to be submitted for approval at a meeting of the Stock Company's shareholders to be held no earlier than six months after the completion of the Reorganization SAIF Savings Association Insurance Fund of the FDIC SEC Securities and Exchange Commission Special Meeting Special Meeting of members of the Bank called for the purpose of approving the Plan of Reorganization Stock Option Plan The Stock Option Plan for directors and officers to be submitted for approval at a meeting of the Stock Company' shareholders to be held no earlier than six months after the completion of the conversion Subscription Offering Offering of non-transferable rights to subscribe for the common stock, in order of priority, to Eligible Account Holders, the ESOP, Supplemental Eligible Account Holders and Other Members. Supplemental Eligible Account Holders Depositors of the Bank, who are not eligible account holders, with account balances of at least $50 on December 31, 1997 Voting Record Date The close of business on __________, 1998, the date for determining depositors entitled to vote at the Special Meeting G-3 - -------------------------------------------------------------------------------- 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 INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE GASTON FEDERAL BANCORP, INC. OR GASTON FEDERAL SAVINGS AND LOAN ASSOCIATION. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY SECURITY OTHER THAN THE SHARES OF COMMON STOCK 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 TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT INFORMATION HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF. GASTON FEDERAL BANCORP, INC. (Proposed Holding Company for Gaston Federal Savings Bank) UP TO 2,113,355 SHARES Common Stock ($1.00 par value per share) SUBSCRIPTION AND COMMUNITY OFFERING PROSPECTUS TRIDENT SECURITIES, INC. February ___, 1998 THESE SECURITIES ARE NOT DEPOSITS OR ACCOUNTS AND ARE NOT FEDERALLY INSURED OR GUARANTEED Until March ___, 1998 or 25 days after the commencement of the offerings of common stock, all dealers effecting transactions in the registered securities, whether or not participating in this distribution, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. - -------------------------------------------------------------------------------- PART II: INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS Proposed federal regulations define areas for indemnity coverage for federal MHC subsidiary holding companies, as follows: (a) Any person against whom any action is brought by reason of the fact that such person is or was a director or officer of the savings association shall be indemnified by the savings association for: (i) Reasonable costs and expenses, including reasonable attorneys' fees, actually paid or incurred by such person in connection with proceedings related to the defense or settlement of such action; (ii) Any amount for which such person becomes liable by reason of any judgment in such action; (iii) Reasonable costs and expenses, including reasonable attorneys' fees, actually paid or incurred in any action to enforce his rights under this section, if the person attains a final judgment in favor of such person in such enforcement action. (b) Indemnification provided for in subparagraph (a) shall be made to such officer or director only if the requirements of this subsection are met: (i) The savings association shall make the indemnification provided by subparagraph (a) in connection with any such action which results in a final judgment on the merits in favor of such officer or director. (ii) The savings association shall make the indemnification provided by subparagraph (a) in case of settlement of such action, final judgment against such director or officer or final judgment in favor of such director or officer other than on the merits except in relation to matters as to which he shall be adjudged to be liable for negligence or misconduct in the performance of duty, only if a majority of the directors of the savings association determines that such a director or officer was acting in good faith within what he was reasonably entitled to believe under the circumstances was the scope of his employment or authority and for a purpose which he was reasonably entitled to believe under the circumstances was in the best interest of the savings association or its members. (c) As used in this paragraph: (i) "Action" means any action, suit or other judicial or administrative proceeding, or threatened proceeding, whether civil, criminal, or otherwise, including any appeal or other proceeding for review; (ii) "Court" includes, without limitation, any court to which or in which any appeal or any proceeding for review is brought; (iii) "Final Judgment" means a judgment, decree, or order which is appealable and as to which the period for appeal has expired and no appeal has been taken; (iv) "Settlement" includes the entry of a judgment by consent or by confession or upon a plea of guilty or of nolo contendere. ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION Amount ------ * Legal Fees and Expenses........................ $ 140,000 * Printing and Mailing............................. 142,600 * Accounting Fees and Expenses..................... 100,000 * Appraisal Fees and Expenses...................... 25,000 ** Marketing Agent Fees............................. 360,000 ** Marketing Agent Legal Fees and Expenses.......... 35,000 * Filing Fees (SEC, OTS and Blue Sky).............. 25,400 * Conversion Agent Fees and Expenses............... 20,000 * Transfer Agent Fees............................ 15,000 * Other Expenses................................... 10,000 ----------- * Total ........................................... $ 873,000 - --------------- * Estimated ** The Association and the Company have retained Trident Securities, Inc. ("Trident") to assist in the sale of common stock on a best efforts basis in the Subscription and Community Offerings. For purposes of computing estimated expenses, it has been assumed that Trident will receive fees of approximately $360,000. ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES. Not Applicable. ITEM 27. 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 Gaston Federal Savings and Loan Association and Trident Securities, Inc. 1.2** Form of Agency Agreement among Gaston Federal Bancorp, Inc., Gaston Federal Savings and Loan Association, and Trident Securities, Inc. 2** Plan of Reorganization 3.1 Proposed Federal Holding Company Charter of Gaston Federal Bancorp, Inc. (Incorporated herein by reference to Exhibit B of the Plan of Reorganization) 3.2 Proposed Bylaws of Gaston Federal Bancorp, Inc. (Incorporated herein by reference to Exhibit B of the Plan of Reorganization) 4** Form of Common Stock Certificate of Gaston Federal Bancorp, Inc. 5 Opinion of Luse Lehman Gorman Pomerenk & Schick, P.C. regarding legality of securities 8.1 Federal Tax Opinion of Luse Lehman Gorman Pomerenk & Schick, P.C. 8.2** State Tax Opinion 8.3** Letter from Feldman Financial Advisors, Inc. with respect to Subscription Rights 10.1** Form of Employment Agreement 10.2** Deferred Compensation and Income Continuation Agreement 10.3** Employee Stock Ownership Plan 10.4** Supplemental Executive Retirement Plan 16 Letter regarding change in accountants 21** Subsidiaries of the Registrant 23.1 Consent of Luse Lehman Gorman Pomerenk & Schick, P.C. (contained in opinion filed as Exhibit 5) 23.2 Consent of Cherry, Bekaert & Holland LLP 23.3** Consent of Feldman Financial Advisors, Inc. 24 Power of Attorney (set forth on Signature Page) 27** EDGAR Financial Data Schedule 99.1** Appraisal Agreement between Gaston Federal Savings and Loan Association and Feldman Financial Advisors, Inc. 99.2** Appraisal Report of Feldman Financial Advisors, Inc. 99.3** Proxy Statement 99.4** Marketing Materials 99.5** Order and Acknowledgment Form - ------------------------------------ *To be filed supplementally or by amendment. **Previously filed. (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 28. UNDERTAKINGS The undersigned Registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, 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; (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement. (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 post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (4) To provide to the underwriter at the closing specified in the underwriting agreements, certificates in such denominations and registered in such names as required by the underwriter to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant 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 Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant 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 Registrant 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 certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form SB-2 and has 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 February 9, 1998. GASTON FEDERAL BANCORP, INC. 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 Gaston Federal Bancorp, Inc. (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 SB- 2 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. Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed below by the following persons in the capacities and as of the dates indicated. Signatures Title Date ---------- ----- ---- /s/ Kim S. Price President and Chief Executive February 9, 1998 ________________________ Officer (Principal Executive Kim S. Price Officer) /s/ Gary F. Hoskins Vice President, Treasurer and February 9, 1998 ________________________ Chief Financial Officer Gary F. Hoskins (Principal Financial and Accounting Officer) /s/ Eugene R. Matthews, II Director February 9, 1998 ________________________ Eugene R. Matthews, II /s/ David W. Hoyle Director February 9, 1998 ________________________ David W. Hoyle /s/ Robert W. Williams, Sr. Director February 9, 1998 ________________________ Robert W. Williams, Sr. Signatures Title Date ---------- ----- ---- /s/ Martha B. Beal Director February 9, 1998 ________________________ Martha B. Beal /s/ James J. Fuller Director February 9, 1998 ________________________ James J. Fuller /s/ William Harvey Keith Director February 9, 1998 ________________________ William Harvey Keith /s/ Charles D. Massey Director February 9, 1998 ________________________ Charles D. Massey /s/ Ben R. Rudisill, II Director February 9, 1998 ________________________ Ben R. Rudisill, II AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 11, 1998 REGISTRATION NO. 333-42951 - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------------------ EXHIBITS TO PRE-EFFECTIVE AMENDMENT NO.2 TO REGISTRATION STATEMENT ON FORM SB-2 ------------------------------------ GASTON FEDERAL BANCORP, INC. EXHIBIT INDEX 1.1** Engagement Letter between Gaston Federal Savings and Loan Association and Trident Securities, Inc.. 1.2** Form of Agency Agreement among Gaston Federal Bancorp, Inc., Gaston Federal Savings and Loan Association, and Trident Securities, Inc. 2** Plan of Reorganization 3.1 Proposed Federal Holding Company Charter of Gaston Federal Bancorp, Inc. (Incorporated herein by reference to Exhibit B of the Plan of Reorganization) 3.2 Proposed Bylaws of Gaston Federal Bancorp, Inc. (Incorporated herein by reference to Exhibit B of the Plan of Reorganization) 4** Form of Common Stock Certificate of Gaston Federal Bancorp, Inc. 5 Opinion of Luse Lehman Gorman Pomerenk & Schick, P.C. regarding legality of securities 8.1 Federal Tax Opinion of Luse Lehman Gorman Pomerenk & Schick, P.C. 8.2** State Tax Opinion 8.3** Letter from Feldman Financial Advisors, Inc. with respect to Subscription Rights 10.1** Form of Employment Agreement 10.2** Deferred Compensation and Income Continuation Agreement 10.3** Employee Stock Ownership Plan 10.4** Supplemental Executive Retirement Plan 21** Subsidiaries of the Registrant 16 Letter regarding change in accountants 21** Subsidiaries of the Registrant 23.1** Consent of Luse Lehman Gorman Pomerenk & Schick, P.C. (contained in opinion filed as Exhibit 5) 23.2 Consent of Cherry, Bekaert & Holland LLP 23.3** Consent of Feldman Financial Advisors, Inc. 24 Power of Attorney (set forth on Signature Page) 27** EDGAR Financial Data Schedule 99.1** Appraisal Agreement between Gaston Federal Savings and Loan Association and Feldman Financial Advisors, Inc. 99.2** Appraisal Report of Feldman Financial Advisors, Inc. 99.3** Proxy Statement 99.4** Marketing Materials 99.5** Order and Acknowledgment Form - ------------------------------------ *To be filed supplementally or by amendment. **Previously filed. EX-5 2 EXHIBIT 5 EXHIBIT 5 [LUSE LEHMAN GORMAN POMERENK & SCHICK LETTERHEAD APPEARS HERE] FORM OF LEGAL OPINION February 10, 1998 The Board of Directors Gaston Federal Savings and Loan Association 245 West Maine Avenue P.O. Box 2249 Gastonia, North Carolina 28053-2249 RE: GASTON FEDERAL BANCORP, INC. COMMON STOCK PAR VALUE $1.00 PER SHARE -------------------------------------- Gentlemen: You have requested the opinion of this firm as to certain matters in connection with the offer and sale (the "Offering") of Gaston Federal Bancorp, Inc. (the "Company") Common Stock, par value $1.00 per share ("Common Stock"). We have reviewed the Company's proposed Stock Holding Company Charter, Registration Statement on Form SB-2 ("Form SB-2"), 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 SB-2 and the incorporation of the Company as a federal corporation, 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 its registration statement on Form SB-2, and we hereby consent to the filing of this Opinion as an exhibit to such registration statement and to our firm being referenced under the caption "Legal and Tax Matters." Very truly yours, LUSE LEHMAN GORMAN POMERENK & SCHICK A PROFESSIONAL CORPORATION By: /s/ Kenneth R. Lehman ___________________________ Kenneth R. Lehman, Esq. EX-8 3 EXHIBIT 8.1 EXHIBIT 8.1 January 27, 1998 Boards of Directors Gaston Federal Savings and Loan Association 55 East Avenue Gastonia, North Carolina 14095-0886 RE: MUTUAL HOLDING COMPANY FORMATION AND STOCK ISSUANCE --------------------------------------------------- Ladies and Gentlemen: We have been requested as special counsel to Gaston Federal Savings and Loan Association to express our opinion concerning certain Federal income tax consequences relating to the proposed conversion of the Bank from a federally chartered mutual savings and loan association (the "Bank") to a federally chartered stock association ("Stock Bank") and the formation of Gaston Federal Holdings, MHC, a federal mutual holding company ("Mutual Holding Company") which will acquire the outstanding stock of Stock Bank and subsequently contribute Stock Bank's stock to Gaston Federal Bancorp, Inc. ("Stock Holding Company"). In connection therewith, we have examined the Plan of Reorganization (as defined below) and certain other documents of or relating to the Reorganization (as defined below), some of which are described or referred to in the Plan of Reorganization and which we deemed necessary to examine in order to issue the opinions set forth below. Unless otherwise defined, all terms used herein have the meanings given to such terms in the Plan of Reorganization. In our examination, we have assumed the authenticity of original documents, the accuracy of copies and the genuineness of signatures. We have further assumed the absence of adverse facts not apparent from the face of the instruments and documents we examined. In issuing our opinions, we have assumed that the Plan of Reorganization has been duly and validly authorized and has been approved and adopted by the board of directors of the Bank at a meeting duly called and held; that the Bank will comply with the terms and conditions of the Plan of Reorganization, and that the various representations and warranties which are provided to us are accurate, complete, true and correct. Accordingly, we express no opinion concerning the effect, if any, of variations from the foregoing. We specifically express no opinion concerning tax matters relating to the Plan of Reorganization under state and local tax laws and under Federal income tax laws except on the basis of the documents and assumptions described above. Boards of Directors Gaston Federal Savings and Loan Association January 27, 1998 Page 2 For purposes of this opinion, we are relying on the representations provided to us by the Bank, which are incorporated herein by reference. In issuing the opinions set forth below, we have referred solely to existing provisions of the Internal Revenue Code of 1986, as amended (the "Code"), existing and proposed Treasury Regulations thereunder, current administrative rulings, notices and procedures and court decisions. Such laws, regulations, administrative rulings, notices and procedures and court decisions are subject to change at any time. Any such change could affect the continuing validity of the opinions set forth below. This opinion is as of the date hereof, and we disclaim any obligation to advise you of any change in any matter considered herein after the date hereof. In rendering our opinions, we have assumed that the persons and entities identified in the Plan of Reorganization will at all times comply with the requirements of Code sections 368 and 351, the other applicable state and Federal laws and the representations of the Bank. In addition, we have assumed that the activities of the persons and entities identified in the Plan of Reorganization will be conducted strictly in accordance with the Plan of Reorganization. Any variations may affect the opinions we are rendering. We emphasize that the outcome of litigation cannot be predicted with certainty and, although we have attempted in good faith to opine as to the probable outcome of the merits of each tax issue with respect to which an opinion was requested, there can be no assurance that our conclusions are correct or that they would be adopted by the IRS or a court. SUMMARY OF OPINIONS ------------------- Based on the facts, representations and assumptions set forth herein, we are of the opinion that: WITH RESPECT TO THE EXCHANGE OF THE BANK'S CHARTER FOR A STOCK CHARTER ("BANK CONVERSION"): 1. Bank's exchange of its charter for a federal stock savings association charter is a mere change in identity and form and therefore qualifies as a reorganization within the meaning of Section 368(a)(1)(F) of the Internal Revenue Code ("Code"). Boards of Directors Gaston Federal Savings and Loan Association January 27, 1998 Page 3 2. No gain or loss will be recognized by Bank upon the transfer of its assets to Stock Bank solely in exchange for shares of Stock Bank stock and the assumption by Stock Bank of the liabilities of Bank. (Code Sections 361(a) and 357(a)). 3. No gain or loss will be recognized by Stock Bank upon the receipt of the assets of Bank in exchange for shares of Stock Bank common stock. (Code Section 1032(a)). 4. Stock Bank's holding period in the assets received from Bank will include the period during which such assets were held by the Bank. (Code Section 1223(2)). 5. Stock Bank's basis in the assets of Bank will be the same as the basis of such assets in the hands of Bank immediately prior to the proposed transaction. (Code Section 362(b)). 6. Bank members will recognize no gain or loss upon the constructive receipt of Stock Bank common stock solely in exchange for their membership interests in Bank. (Code Section 354(a)(1)). 7. The basis of the Stock Bank common stock to be constructively received by the Bank's members will be the same as their basis in their membership interests in the Bank surrendered in exchange therefor. (Code Section 358(a)(1)). 8. The holding period of the Stock Bank common stock constructively received by the members of the Bank will include the period during which the Bank members held their membership interests, provided that the membership interests were held as capital assets on the date of the exchange. (Code Section 1223(1)). 9. The Stock bank will succeed to and take into account the Bank's earnings and profits or deficit in earnings and profits, as of the date of the proposed transaction. (Code Section 381). WITH RESPECT TO THE TRANSFER OF STOCK BANK STOCK TO MUTUAL HOLDING COMPANY FOR MEMBERSHIP INTERESTS (THE "351 TRANSACTION"): Boards of Directors Gaston Federal Savings and Loan Association January 27, 1998 Page 4 10. The exchange of stock by the Stock Bank stockholders in exchange for membership interests in the Mutual Holding Company will constitute a tax-free exchange of property solely for voting "stock" pursuant to Section 351 of the Internal Revenue Code. 11. Stock Bank's stockholders will recognize no gain or loss upon the transfer of the Stock Bank stock they constructively received in the Bank conversion to the Mutual Holding Company solely in exchange for membership interests in the Mutual Holding Company. (Code Section 351). 12. Stock Bank stockholder's basis in the Mutual Holding Company membership interests received in the transaction will be the same as the basis of the property transferred in exchange therefor, reduced by the sum of the liabilities assumed by Mutual Holding Company or to which assets transferred are taken subject. (Code Section 358(a)(1)). 13. Stock Bank stockholder's holding period for the membership interests in Mutual Holding Company received in the transaction will include the period during which the property exchanged was held by Stock Bank stockholders, provided that such property was a capital asset on the date of the exchange. (Code Section 1223(1)). 14. Mutual Holding Company will recognize no gain or loss upon the receipt of property from Stock Bank stockholders in exchange for membership interests in the Mutual Holding Company. (Code Section 1032(a)). 15. Mutual Holding Company's basis in the property received from Stock Bank stockholders will be the same as the basis of such property in the hands of Stock Bank stockholders immediately prior to the transaction. (Code Section 362(a)). 16. Mutual Holding Company's holding period for the property received from Stock Bank's stockholders will include the period during which such property was held by Stock Bank stockholders. (Code Section 1223(2)). 17. Stock Bank depositors will recognize no gain or loss solely by reason of the transaction. WITH RESPECT TO THE TRANSFERS TO THE STOCK HOLDING COMPANY IN EXCHANGE FOR COMMON STOCK IN THE STOCK HOLDING COMPANY Boards of Directors Gaston Federal Savings and Loan Association January 27, 1998 Page 5 18. The Mutual Holding Company and the persons who purchased Common Stock of the Stock Holding Company in the Subscription and Community Offering ("Minority Stockholders") will recognize no gain or loss upon the transfer of Stock Bank stock and cash, respectively, to the Stock Holding Company in exchange for stock in the Stock Holding Company. Code Sections 351(a) and 357(a). 19. Stock Holding Company will recognize no gain or loss on its receipt of Stock Bank stock and cash in exchange for Stock Holding Company Stock. (Code Section 1032(a)). 20. The basis of the Stock Holding Company Common Stock to the Minority Stockholders will be the actual purchase price thereof, and a shareholders holding period for Common Stock acquired through the exercise of subscription rights will begin on the date the rights are exercised. PROPOSED TRANSACTION -------------------- On July 14, 1997, the board of directors of the Bank adopted that certain Plan of Reorganization From A Mutual Savings Association to A Mutual Holding Company and Stock Issuance Plan (the "Plan of Reorganization"). For what are represented to be valid business purposes, the Bank's board of directors has decided to convert to a mutual holding company structure pursuant to statutes. The following steps are proposed: (i) The Bank will organize an interim stock savings bank (Interim One) as its wholly-owned subsidiary; (ii) Interim One will organize a federal mid-tier holding company as its wholly-owned subsidiary (Stock Holding Company); and (iii) Interim One will also organize another interim federal stock savings bank as its wholly-owned subsidiary (Interim Two). The following transactions will occur simultaneously: (iv) The Bank will exchange its charter for a federal stock savings bank charter and become a stock savings bank that will constructively issue its common stock to members of the Bank; Boards of Directors Gaston Federal Savings and Loan Association January 27, 1998 Page 6 (v) Interim One will cancel its outstanding stock and exchange its charter for a federal mutual holding company charter and thereby become the Mutual Holding Company; (vi) Interim Two will merge with and into the Bank with the Bank as the surviving entity, the former members of the Bank who constructively hold stock in the Bank will exchange their stock in the Bank for membership interests in the Mutual Holding Company; and (vii) The Mutual Holding Company will contribute the Bank's stock to the Stock Holding Company, a wholly-owned subsidiary of the Mutual Holding Company for additional shares of Bank Stock. (viii) Contemporaneously, with the contribution set forth in "(vii)" the Stock Holding Company will offer to sell up to 49.9% of its Common Stock in the Subscription Offering and, if applicable, the Direct Community Offering. These transactions are referred to herein collectively as the "Reorganization." Those persons who, as of the date of the Bank Conversion (the "Effective Date"), hold depository rights with respect to the Bank will thereafter have such rights solely with respect to the Stock Bank. Each deposit account with the Bank at the time of the exchange will become a deposit account in the Stock Bank in the same amount and upon the same terms and conditions. Following the completion of the Reorganization, all depositors and borrowers who had membership rights with respect to the Bank immediately prior to the Reorganization will continue to have such rights solely with respect to the Mutual Holding Company so long as they continue to hold deposit accounts or borrowings with the Stock Bank. All new depositors of the Stock Bank after the completion of the Reorganization will have ownership rights solely with respect to the Mutual Holding Company so long as they continue to hold deposit accounts with the Stock Bank. The shares of Interim Two common stock owned by the Mutual Holding Company prior to the Reorganization shall be converted into and become shares of common stock of the Stock Bank on the Effective Date. The shares of Stock Bank common stock constructively received by the Stock Bank stockholders (formerly the members holding liquidation rights of the Bank) will be transferred to the Mutual Holding Company by such persons in exchange for liquidation rights in the Mutual Holding Company. Boards of Directors Gaston Federal Savings and Loan Association January 27, 1998 Page 7 The Stock Holding Company will have the power to issue shares of capital stock (including common and preferred stock) to persons other than the Mutual Holding Company. So long as the Mutual Holding Company is in existence, however, it must own a majority of the voting stock of Stock Holding Company. Stock Holding Company may issue any amount of non-voting stock to persons other than Mutual Holding Company. No such non-voting stock will be issued as of the date of the Reorganization. * * * The opinions set forth above represent our conclusions as to the application of existing Federal income tax law to the facts of the instant transaction, and we can give no assurance that changes in such law, or in the interpretation thereof, will not affect the opinions expressed by us. Moreover, there can be no assurance that contrary positions may not be taken by the IRS, or that a court considering the issues would not hold contrary to such opinions. All of the opinions set forth above are qualified to the extent that the validity of any provision of any agreement may be subject to or affected by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the rights of creditors generally. We do not express any opinion as to the availability of any equitable or specific remedy upon any breach of any of the covenants, warranties or other provisions contained in any agreement. We have not examined, and we express no opinion with respect to the applicability of, or liability under, any Federal, state or local law, ordinance, or regulation governing or pertaining to environmental matters, hazardous wastes, toxic substances, asbestos, or the like. It is expressly understood that the opinions set forth above represent our conclusions based upon the documents reviewed by us and the facts presented to us. Any material amendments to such documents or changes in any significant fact would affect the opinions expressed herein. Boards of Directors Gaston Federal Savings and Loan Association January 27, 1998 Page 8 We have not been asked to, and we do not, render any opinion with respect to any matters other than those expressly set forth above. This opinion is rendered solely for the benefit of the Mutual Holding Company, the Stock Holding Company, the Association and prospective investors in connection with the proposed transactions described herein and is not to be relied upon by any other person or entity without our express written consent. We hereby consent to the filing of the opinion as an exhibit to the Bank's combined Form MHC-1/MHC-2 Notice of Mutual Holding Company Reorganization and Application for Approval of a Minority Stock Issuance by a Subsidiary of Mutual Holding Company as filed with the OTS and to the Stock Holding Company's Registration Statement on Form SB-2 as filed with the SEC. We also consent to the references to our firm in the Prospectus contained in the Forms MHC-1/MHC-2 and SB-2 under the captions "The Reorganization and Offering - Federal and State Tax Consequences of the Reorganization" and "Legal and Tax Matters," and to the summarization of our opinion in such Prospectus. Very truly yours, /s/ Luse Lehman Gorman Pomerenk & Schick ________________________________________ LUSE LEHMAN GORMAN POMERENK & SCHICK A Professional Corporation EX-16 4 EXHIBIT 16 EXHIBIT 16 Butler & Stowe CERTIFIED PUBLIC ACCOUNTANTS P.O. Box 2379 o 109 W. Third Avenue Gastonia, North Carolina 28053 704-864-8311 o FAX 704-864-1716 February 10, 1998 Securities and Exchange Commission Gentlemen We have been advised, as former accountants of Gaston Federal Savings & Loan Association (the Bank) that the following disclosure is to be made in the Bank's Prospectus: On August 18, 1997, Butler & Stowe, the independent accountants who were previously engaged as principal accountant to audit the Bank's financial statements resigned, and the Bank retained Cherry, Bekaert & Holland, L.L.P., independent auditors. The change in accountants was approved by the Bank's Board of Directors. The prior accountant's report on the financial statements as of and for the fiscal year ended September 30, 1996, did not contain an adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope, or accounting principles. During the Bank's two most recent fiscal years preceding such resignation there were no disagreements with the former accountant on any matter of accounting principles or practices, financial statement disclosure, or auditing scope of procedure, nor were there any other events that require reporting under SEC regulations. We agree with this disclosure as it is stated here. Very truly yours, BUTLER & STOWE, CPAs /s/ Robert W. Adams ------------------- Robert W. Adams, CPA Partner RWA:dc Members: American Institute of Certified Public Accountants o North Carolina Association of Certified Public Accountants EX-23 5 EXHIBIT 23.2 EXHIBIT 23.2 The Board of Directors Gaston Federal Savings and Loan Association We consent to the use in this Amendment No. 2 to the registration statement (No. 333-42951) on Form SB-2 of Gaston Federal Bancorp, Inc. of our report dated October 24, 1997 with respect to the financial statements of Gaston Federal Savings and Loan Association as of September 30, 1997 and 1996 and for the years then ended included herein, the use of our opinion as to the North Carolina income tax consequences of the offering as described therein and included herein, and to the reference to our firm under the heading "Experts" in the prospectus. /s/ Cherry, Bekaert & Holland, L.L.P. Gastonia, North Carolina February 10, 1998 -----END PRIVACY-ENHANCED MESSAGE-----