-----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, I9eDa4DfuSG03lp83A27qtOzemmKFf/sWEtszGPQwDkilIEpnrzefrksBtfyBHlh JiHCX4WLmAG4Uc4pYyujlw== 0000950168-99-001001.txt : 19990423 0000950168-99-001001.hdr.sgml : 19990423 ACCESSION NUMBER: 0000950168-99-001001 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ECB BANCORP INC CENTRAL INDEX KEY: 0001066254 STANDARD INDUSTRIAL CLASSIFICATION: 6022 IRS NUMBER: 562090738 STATE OF INCORPORATION: NC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 000-24753 FILM NUMBER: 99580912 BUSINESS ADDRESS: STREET 1: P O BOX 337 STREET 2: HWY 264 CITY: ENGELHARD STATE: NC ZIP: 27824 BUSINESS PHONE: 2529259411 10KSB 1 ECB BANCORP, INC. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 COMMISSION FILE NO. 0-24753 ECB BANCORP, INC. (Name of small business issuer in its charter) - - ----------------------------------------- ---- ------------------------------- NORTH CAROLINA 56-2090738 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) - - ----------------------------------------- ---- ------------------------------- POST OFFICE BOX 337 ENGELHARD, NORTH CAROLINA 27824 (Address of principal executive offices) (Zip Code) - - ----------------------------------------- ---- ------------------------------- (252) 925-9411 Registrant's telephone number, including area code Securities registered under Section 12(b) of the Act: NONE Securities registered under Section 12(g) of the Act: COMMON STOCK, $3.50 PAR VALUE PER SHARE (Title of class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ---------- --------- Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. YES X NO ----------- --------- Registrant's revenues for its most recent fiscal year were: $ 16,909,358 ------------ On March 24, 1999, the aggregate market value of the voting and non-voting common equity held by nonaffiliates (computed by reference to the price at which the common equity was sold, or the average bid and asked price of such common equity) was $19,541,691. On March 24, 1999, the number of outstanding shares of Registrant's common stock was 2,125,254. DOCUMENTS INCORPORATED BY REFERENCE Portions of Registrant's Annual Report to Shareholders for the year ended December 31, 1998, are incorporated herein in Part II. Portions of Registrant's definitive Proxy Statement dated March 29, 1999, are incorporated herein in Part III. PART I ITEM 1. DESCRIPTION OF BUSINESS GENERAL. Registrant is a bank holding company headquartered in Engelhard, North Carolina. Registrant operates through, and its principal asset is its investment in, The East Carolina Bank (the "Bank") which operates as Registrant's wholly-owned subsidiary. As part of the Bank's growth strategy, management of the Bank perceived that the reorganization of the Bank into a holding company form of organization likely would result in certain advantages, including, without limitation, additional flexibility in expansion of the Bank's business through the acquisition of other financial institutions, in the raising of additional capital through borrowing (if needed) and with respect to other activities and corporate matters. Additionally, such a reorganization could benefit the Bank's shareholders through increased public awareness and additional liquidity in the trading market for the holding company's outstanding equity securities. As a result, Registrant was organized on March 4, 1998, by the Bank and at the direction of the Bank's Board of Directors, to serve as the Bank's parent holding company. Effective July 22, 1998, and to effect the reorganization, (i) an "interim bank" subsidiary of Registrant (newly formed for the purpose of such transaction) was merged into the Bank (with the Bank as the surviving corporation), (ii) the outstanding shares of the Bank's common stock were converted into an identical number of shares of Registrant's Common Stock with the result that the then current shareholders of the Bank became shareholders of Registrant (with the same relative ownership interests that they had in the Bank) and (iii) Registrant became the Bank's sole shareholder. The Bank continues to exist under its separate charter and bylaws but as the wholly-owned subsidiary of Registrant, and continues to conduct its banking business at all its previous banking offices. THE BANK. The Bank is an FDIC-insured, North Carolina-chartered bank which was organized in 1919 and is engaged in a general, community-oriented commercial and consumer banking business. The Bank currently maintains 15 full-service banking offices in six counties in North Carolina, together with one loan production office, and its deposits are insured under the FDIC's Bank Insurance Fund ("BIF") to the maximum amount permitted by law. The Bank has two wholly-owned subsidiaries. Carolina Financial Realty, Inc. ("CFR") holds title to five of the Bank's branch offices which it leases to the Bank. The second subsidiary, Carolina Financial Courier, Inc., formerly provided courier services to the Bank but currently contracts with a third-party for such services. The Bank's operations are primarily retail oriented and directed toward individuals, small- and medium-sized businesses and local governmental units located in its banking markets, and its deposits and loans are derived primarily from customers in its banking markets. While the Bank provides most traditional commercial and consumer banking services, its principal activities are the taking of demand and time deposits and the making of secured and unsecured loans. The Bank's primary source of revenue is interest income from its lending activities, and it has pursued a strategy of growth through internal expansion by establishing branch offices in communities within its banking markets. The Bank's banking markets are located in the east central and northeastern portions of North Carolina and along North Carolina's Outer Banks. The Bank makes a variety of types of consumer and commercial loans to individuals and small- and medium-sized businesses located primarily in its banking markets for various personal, business and agricultural purposes, including term and installment loans, equity lines of credit and overdraft checking credit. The Bank's loans are concentrated in four major areas: (i) real estate loans, (ii) commercial and agricultural loans, (iii) installment loans and (iv) credit card loans. At December 31, 1998, approximately 48.5% of the Bank's loan portfolio consisted of real estate loans. All real estate loans are secured by first or junior liens on real property located almost exclusively in the Bank's geographic markets (and substantially all of which, both commercial and residential, is owner occupied or operated), and management estimates that more than approximately 75% of those loans actually were made for purposes related to the real estate collateral (generally, loans made to individuals and businesses for the purchase and improvement of or investment in real estate, including construction loans to individuals and builders). However, in addition to such real estate purpose loans, the Bank also makes loans secured by first or junior liens on real estate for various other commercial, agricultural and consumer purposes. Such loans generally are reflective of efforts by management to minimize credit risk by taking real estate as primary or additional collateral on loans made for purposes not directly related to the real estate itself. The Bank does not make conventional, long-term residential mortgage loans in its own name, and none of its other real estate loans are made with the intent to sell them in the secondary market. Therefore, none of such loans are underwritten to conform to FNMA or FHLMC guidelines. Loans secured by real estate may be made at fixed or variable interest rates and for terms of up to 15 years, or which provide for payments based on an amortization schedule of up to 15 years. However, loans having terms of more than five years, or which are based on an amortization schedule of more than five years, generally will contain contractual provisions which allow the Bank to call the loan in full, or provide for a "balloon" payment in full, at the end of each five-year period. The Bank's commercial and agricultural loans include loans to individuals and small- and medium-sized businesses located in its banking markets for working capital, equipment purchases and various other business and agricultural purposes (other than any such loan secured by real estate) and loans made to finance the production of crops. A majority of the Bank's commercial and agricultural loans are secured by inventory, equipment, crops or similar assets, but these loans also may be made on an unsecured basis. Commercial and agricultural loans may be made at variable or fixed rates of interest; however, it currently is the Bank's policy that those loans which have terms or amortization schedules of longer than five years normally will carry interest rates which vary with the prime lending rate and may be called in full at any time after the first five years. The Bank's installment loan portfolio consists primarily of loans to individuals for various consumer purposes (other than any such loan secured by real estate), but also includes the outstanding balances on consumer revolving credit accounts. The majority of the Bank's installment loans are secured by liens on various personal assets of the borrowers, but these loans may also be made on an unsecured basis. Consumer loans generally are made at fixed interest rates (with the exception of revolving credit accounts which may provide for variable rates) and for terms which generally do not exceed three years. However, the Bank will make consumer loans for terms of up to five years. The Bank is an issuer of MasterCard and Visa credit cards (primarily to customers within its banking markets). During 1998, the Bank began offering long-term, residential mortgage loans that are originated by the Bank but are underwritten and funded by, and closed in the name of, third-party lenders. The Bank retains a portion of the origination fees collected with respect to these loans. This arrangement permits the Bank to offer this product in its markets and enhance its fee-based income, but it avoids the credit and interest rate risk associated with long-term loans since these loans are not in the Bank's loan portfolio. As described above, the Bank's loan portfolio consists primarily of loans made for a variety of commercial, agricultural and consumer purposes and the Bank does not make long-term residential mortgage loans for its own account. Because these types of loans are made based, to a great extent, on the Bank's assessment of borrowers' income, cash flow, character and ability to repay (as compared to long-term residential mortgage loans in which greater emphasis is placed on collateral), such loans are viewed as involving a higher degree of credit risk than is the case with long-term residential mortgage loans. To manage this risk, the Bank's loan portfolio is managed under a defined process, which includes guidelines for loan underwriting standards and risk assessment, procedures for loan approvals, loan grading, ongoing identification and management of credit deterioration and portfolio reviews to assess loss exposure and to ascertain compliance with the Bank's credit policies and procedures. The Bank has retained an outside credit risk management consultant to advise the Bank with respect to its credit policies and procedures and to provide on-line credit manuals that can be modified quickly and efficiently to reflect periodic changes. The lending and loan administration process includes a centralized credit review and analysis prior to funding of all credit decisions involving an aggregate credit relationship in excess of $200,000, a review of all loans after funding for adequacy of documentation and compliance with regulatory requirements and a review by credit administration personnel at least annually of any credit relationship exceeding $100,000. Additionally, the Bank's credit risk management consultant currently reviews the Bank's 15 largest lending relationships and other selected loans three times a year. Reports of the results of these outside reviews are made to the Board of Directors. At the time loans are made, and during periodic reviews, loans are assigned a grade which indicates the level of management attention to be given to that loan to protect the Bank's position and to reduce loss exposure. During the life of each loan, its grade is reviewed and validated or modified to reflect changes in circumstances and risk. Loans are placed in a non-accrual status if they become 90 days past due or otherwise whenever, in the opinion of management, collection becomes doubtful, and they are charged off when the collection of principal and interest is doubtful and the loans can no longer be considered sound collectible assets (or, in the case of unsecured loans, when they become 90 days past due). The General Credit Committee reviews all substandard loans over $10,000 on a quarterly basis, and management of the Bank meets regularly to review asset quality trends and to discuss loan policy issues. Based on these reviews and other factors (including a defined formula that takes into consideration general and specific credit risks in the Bank's loan portfolio), the Bank has established a reserve for loan losses. The adequacy of the reserve is assessed by management of the Bank and reviewed by the Bank's Board of Directors each month. The Bank's deposit services include business and individual checking accounts, savings accounts, NOW accounts, certificates of deposit and money market checking accounts. It is the Bank's policy to monitor its competition in order to keep the rates paid on its deposits at a competitive level. The Bank's banking markets include primarily smaller communities where its emphasis on customer service provides it with a stable source of core funding. The vast majority of the Bank's deposits are generated from within its banking markets, and the Bank does not accept brokered deposits but does actively solicit public funds deposits in its markets. The Bank competes for deposits in its banking markets with other commercial banks, savings banks and other thrift institutions, credit unions, agencies issuing United States government securities and all other organizations and institutions engaged in money market transactions. In its lending activities, the Bank competes with all other financial institutions as well as consumer finance companies, mortgage companies and other lenders. Commercial banking in the Bank's banking markets and in North Carolina as a whole is extremely competitive. North Carolina is the home of three of the largest commercial banks in the Southeast, each of which has branches located in certain of the Bank's markets, and 14 other commercial banks, thrift institutions and credit unions also are represented in its banking markets. Interest rates, both on loans and deposits, and prices of fee-based services, are significant competitive factors among financial institutions generally. Other important competitive factors include office location, office hours, the quality of customer service, community reputation, continuity of personnel and services, and, in the case of larger commercial customers, relative lending limits and the ability to offer more sophisticated cash management and other commercial banking services. Many of the Bank's competitors have greater resources, broader geographic markets and higher lending limits than the Bank, and they can offer more products and services and can better afford and make more effective use of media advertising, support services and electronic technology than can the Bank. The Bank depends on its reputation as a community bank in its local markets, its direct customer contact, its ability to make credit and other business decisions locally, and its personalized service, to counter these competitive disadvantages. In recent years, federal and state legislation has heightened the competitive environment in which all financial institutions must conduct their business, and the potential for competition among financial institutions of all types has increased significantly. Additionally, with the elimination of restrictions on interstate banking, a North Carolina commercial bank may be required to compete not only with other North Carolina-based financial institutions, but also with out-of-state financial institutions which may acquire North Carolina institutions, establish or acquire branch offices in North Carolina, or otherwise offer financial services across state lines, thereby adding to the competitive atmosphere of the industry in general. In terms of assets, the Bank is one of the smaller commercial banks in North Carolina, and there is no assurance that the Bank will be or continue to be an effective competitor in the current financial services environment. Registrant does not have any separate employees. As of December 31, 1998, the Bank employed 131 full-time employees (including its and Registrant's executive officers) and 14 part-time employees. The Bank and its employees are not parties to any collective bargaining agreement, and the Bank considers its relations with its employees to be good. ITEM 2. PROPERTIES. Registrant's offices are located in the Bank's corporate offices in Engelhard, North Carolina, and Registrant does not own or lease any separate properties. The Bank maintains the following 16 offices, seven of which it owns, five of which are owned by CFR and leased to the Bank, three of which are held under leases with unaffiliated third parties, and one of which was constructed by the Bank on property held under a ground lease with an unaffiliated third party. All of the Bank's existing banking offices are in good condition and fully equipped for the Bank's purposes. CENTRAL REGION: Engelhard main banking and corporate office (owned) Swan Quarter branch office (owned) Fairfield branch office (leased from CFR) Columbia branch office (leased from CFR) Creswell branch office (owned) Washington loan production office (leased) WESTERN REGION: Greenville Arlington branch office (owned) Greenville University Medical Center branch office (owned) Greenville WalMart Supercenter branch office (leased) OUTER BANKS REGION: Barco branch office (ground lease) Southern Shores/Kitty Hawk branch office (leasedfrom CFR) Nags Head branch office (leased from CFR) Manteo branch office (owned) Avon branch office (leased) Hatteras branch office (leased from CFR) Ocracoke branch office (owned) (B) OTHER PROPERTIES OWNED BY THE BANK None ITEM 3. LEGAL PROCEEDINGS. At December 31, 1998, Registrant was not a party to any legal proceeding that is expected to have a material effect on its financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET INFORMATION. Registrant's Common Stock was first issued on July 22, 1998, which is the date upon which Registrant became [THE BANK'S] parent holding company and its shares were issued in exchange for [THE BANK'S] outstanding shares. The Common Stock was listed for trading on the Nasdaq Small Cap Market (under the symbol "ECBE") on November 23, 1998. Previously, it had been listed on the Nasdaq Bulletin Board. However, there is not an active trading market for shares of the Common Stock. Registrant has been informed that, between July 22, 1998, and December 31, 1998, its Common Stock has traded in isolated transactions on the Nasdaq Bulletin Board and the Nasdaq Small Cap Market at prices ranging from $13.50 to $20.00 per share. On March 12, 1999, there were approximately 721 holders of record of Registrant's Common Stock. Between July 22, 1998, and December 31, 1998, Registrant declared one cash dividend on its Common Stock in the amount of $.255 per share which was payable on December 7, 1998. Registrant's sole source of funds for the payment of dividends on the Common Stock is dividends paid to it by [THE BANK] on the shares of [THE BANK'S] common stock held by Registrant, and the declaration and payment of future dividends by [THE BANK] will continue to depend on [THE BANK'S] earnings and financial condition, capital requirements, general economic conditions, compliance with regulatory requirements generally applicable to North Carolina banks, and other factors. Registrant's ability to pay dividends also is subject to its own separate factors, including its earnings and financial condition, capital requirements and regulatory restrictions applicable to bank holding companies. SALES OF COMMON STOCK. During 1998, Registrant issued shares of its Common Stock as described below. (A) BANK HOLDING COMPANY REORGANIZATION. Registrant was organized by [THE BANK] and at the direction of [THE BANK'S] Board of Directors, to serve as [THE BANK'S] parent holding company. Effective July 22, 1998, and to effect the reorganization, (i) an "interim bank" subsidiary of Registrant (newly formed for the purpose of such transaction) was merged into [THE BANK], (ii) the outstanding shares of [THE BANK'S] common stock were converted into an identical number of shares of Registrant's Common Stock with the result that [THE BANK'S] the then current shareholders became shareholders of Registrant (with the same relative ownership interests that they had in [THE BANK]) and (iii) Registrant became the sole shareholder of [THE BANK]. An aggregate of 1,780,254 shares of Registrant's Common Stock were issued to effect the bank holding company reorganization. In issuing its shares to [THE BANK'S] shareholders, Registrant relied upon Section 3(a)(12) of the Securities Act of 1933. (B) PUBLIC OFFERING. On November 23, 1998, Registrant completed a public offering in which it sold, through Interstate/Johnson Lane Corporation (which acted as underwriter for the offering), an aggregate of 345,000 shares of its Common Stock at a price to the public of $14.25 per share. Aggregate underwriting discounts in the offering were [$368,719]. In connection with the public offering, the following information is provided: (1) Effective date of Registration Statement on Form SB-1: November 12, 1998 Commission file number: 333-61839 (2) Date offering commenced: November 12, 1998 (3) (I) The offering terminated after the sale of all shares registered. (II) Underwriters: Interstate/Johnson Lane Corporation (III) Title of class of securities registered: Common Stock, $3.50 par value (IV) Amount registered: 345,000 shares Aggregate offering price of amount registered: $4,916,250 Amount sold: 345,000 shares Aggregate offering price of amount sold: $4,916,250 (V) Expenses: Underwriting discounts and commissions: $368,719 Finders' fees: 0 Expenses paid to or for underwriters: 19,635 Other expenses: 259,629 Total expenses: $647,983 None of such expenses were paid to or for any of Registrant's directors, officers, or principal shareholders. (VI) Net offering proceeds to Registrant after deduction of total expenses: $4,268,267 (VII) Application of net proceeds: Construction of plant, building and facilities: $-0- Purchase and installation of machinery and equipment: -0- Purchase of real estate: -0- Acquisition of other businesses: -0- Working capital: $4,268,267 Temporary investments: -0- None of such proceeds were paid to any of Registrant's directors, officers or principal shareholders. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION. Incorporated herein by reference to pages 31 through 47 of Registrant's 1998 Annual Report to Shareholders. ITEM 7. FINANCIAL STATEMENTS. Incorporated herein by reference to pages 11 through 29 of Registrant's 1998 Annual Report to Shareholders. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS. Not applicable. PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT. Incorporated herein by reference from pages 3 through 4, and page 6 (under the captions "Section 16(a) Beneficial Ownership Reporting Compliance," "Proposal 1: Election of Directors" and "Executive Officers") of Registrant's definitive Proxy Statement dated March 29, 1999. ITEM 10. EXECUTIVE COMPENSATION. Incorporated herein by reference from pages 5 through 8 (under the caption "Director Compensation," "Executive Compensation" and "Stock Options") of Registrant's definitive Proxy Statement dated March 29, 1999. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Incorporated herein by reference to pages 2 through 3 (under the caption "Beneficial Ownership of Securities") of Registrant's definitive Proxy Statement dated March 29, 1999. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Incorporated herein by reference to page 8 (under the caption "Transactions with Management") of Registrant's definitive Proxy Statement dated March 29, 1999. ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K. (A) EXHIBITS. The following exhibits are filed herewith or incorporated herein by reference as part of this Report. EXHIBIT NUMBER DESCRIPTION ------ ----------- 3.1 Registrant's Restated Articles of Incorporation (incorporated by reference from Exhibit 3.1 Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 3.2 Registrant's Bylaws (incorporated by reference from Exhibit 3.2 to Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 10.1 Employment Agreement between Arthur H. Keeney, III and the Bank (incorporated by reference from Exhibit 10.1 to Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 10.2 Omnibus Stock Ownership and Long Term Incentive Plan (incorporated by reference from Exhibit 10.2 to Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 10.3 Form of Employee Stock Option Agreement (incorporated by reference from Exhibit 10.3 to Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 13.1 Registrant's 1998 Annual Report to Shareholders (filed herewith) 22 List of subsidiaries of Registrant (incorporated by reference from Exhibit 21.1 to Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 27 Financial data schedule (filed herewith) 99 Registrant's definitive Proxy Statement dated March 29, 1999, as filed with the Securities and Exchange Commission (not being refiled) (B) REPORTS ON FORM 8-K. During the last quarter of the period covered by this Report on Form 10-KSB, Registrant filed one (1) Current Report on Form 8-KSB as follows: On October 27, 1998 reporting its financial results for the nine months ended September 30, 1998, and that its Board of Directors had declared a cash dividend on its outstanding common stock. SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, Registrant caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. ECB BANCORP, INC. DATE: MARCH 24, 1999 BY: /s/ --------------------------------------- Arthur H. Keeney, III President and Chief Executive Officer In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- _/s/____________________________ President, Chief Executive March 24, 1999 Arthur H. Keeney, III Officer and Director (principal executive officer) _/s/____________________________ Senior Vice President and March 24, 1999 Gary M. Adams Chief Financial Officer (principal financial and accounting officer) _/s/____________________________ Chairman March 24, 1999 R. S. Spencer, Jr. _/s/____________________________ Director March 24, 1999 George T. Davis, Jr. _/s/____________________________ Director March 24, 1999 C. Gilbert Gibbs _/s/_____________________________ Director March 24, 1999 Gregory C. Gibbs
_/s/____________________________ Director March 24, 1999 John F. Hughes, Jr. _/s/____________________________ Director March 24, 1999 J. Bryant Kittrell, III _/s/____________________________ Director March 24, 1999 Joseph T. Lamb, Jr. _/s/____________________________ Director March 24, 1999 B. Martelle Marshall _/s/____________________________ Director March 24, 1999 Robert L. Mitchell _/s/____________________________ Director March 24, 1999 Ray M. Spencer
EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION ------ ----------- 3.1 Registrant's Restated Articles of Incorporation (incorporated by reference from Exhibit 3.1 to Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 3.2 Registrant's Bylaws (incorporated by reference from Exhibit 3.2 to Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 10.1 Employment Agreement between Arthur H. Keeney, III and the Bank (incorporated by reference from Exhibit 10.1 to Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 10.2 Omnibus Stock Ownership and Long Term Incentive Plan (incorporated by reference from Exhibit 10.2 to Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 10.3 Form of Employee Stock Option Agreement (incorporated by reference from Exhibit 10.3 to Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 13.1 Registrant's 1998 Annual Report to Shareholders (filed herewith) 22 List of subsidiaries of Registrant (incorporated by reference from Exhibit 21.1 Registrant's Registration Statement on Form SB-2, Reg. No. 333-61839) 27 Financial data schedule (filed herewith) 99 Registrant's definitive Proxy Statement dated March 29, 1999, as filed with the Securities and Exchange Commission (not being refiled) EX-13 2 EXHIBIT 13 MISSION STATEMENT The East Carolina Bank will be operated in a financially sound manner and will achieve its growth and profit objectives through the delivery of select, quality financial products and services to individuals, small business, and agricultural customers in eastern North Carolina. We will be dedicated to employee development, strive to exceed the public's expectations with our service orientation, and seek to have our corporate values reflect those of the community. The result shall be a high performance independent bank providing career opportunities for our employees, superior returns for our shareholders, and Excellence in Community Banking for our customers. TABLE OF CONTENTS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries 1998 ANNUAL REPORT Shareholder Reference ................................................... 3 Letter to Shareholders .................................................. 4-5 The Newman's Own George Award ........................................... 7 Financial Highlights .................................................... 8-9 Consolidated Five Year Financial Summary ................................ 10 Independent Auditors' Report ............................................ 11 Consolidated Balance Sheets ............................................. 12 Consolidated Statements of Income ....................................... 13 Consolidated Statements of Shareholders' Equity ......................... 14 Consolidated Statements of Cash Flows ................................... 15 Notes to Consolidated Financial Statements .............................. 16-29 Management's Discussion and Analysis .................................... 31-47 Board of Directors and Subsidiary Corporations .......................... 48 Bank Senior Management and Corporate Officers ........................... 49 Bank Officers and Department Managers ................................... 50 Branch Officers ......................................................... 51 Attorneys and Correspondent Banks ....................................... 52 - - -------------------------------------------------------------------------------- FORWARD-LOOKING STATEMENTS The Private Securities Litigation Reform Act of 1995 evidences Congress' determination that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by Company management. This Annual Report, including the Letter to Shareholders and Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that involve risk and uncertainty. In order to comply with the terms of the safe harbor, the Company notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forward-looking statements. The risks and uncertainties that may affect the operations, performance, development, growth projections and results of the Company's business include, but are not limited to, the growth of the economy, interest rate movements, timely development by the Company of technology enhancements for its products and operating systems, the impact of competitive products, services and pricing, customer business requirements, Congressional legislation and similar matters. Readers of this report are cautioned not to place undue reliance on forward-looking statements which are subject to influence by the named risk factors and unanticipated future events. Actual results, accordingly, may differ materially from management expectations. - - -------------------------------------------------------------------------------- 2 SHAREHOLDER REFERENCE - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries ANNUAL MEETING The Annual Shareholders' Meeting will be held Wednesday, April 28, 1999 at 11:00 a.m. at the Lodge at Lake Mattamuskeet, Hyde County, North Carolina. HEADQUARTERS Post Office Box 337 35080 US Highway 264 Engelhard, North Carolina 27824 (252) 925-9411 FORM 10-KSB Copies of ECB Bancorp, Inc.'s Annual Report Form 10-KSB to the Securities and Exchange Commission may be obtained without charge by writing to Gary M. Adams, Senior VP & Chief Financial Officer, The East Carolina Bank, P.O. Box 337, Engelhard, North Carolina 27824. ANNUAL DISCLOSURE STATEMENT A copy of the Bank's Annual Disclosure Statement may be obtained without charge by contacting Gary M. Adams, Senior VP & Chief Financial Officer, The East Carolina Bank, P.O. Box 337, Engelhard, North Carolina 27824. STOCK TRANSFER AND REGISTRAR First Citizens Bank & Trust Company P.O. Box 151 Raleigh, North Carolina 27602 SHAREHOLDER ACCOUNT INQUIRIES Communications regarding transfer requirements and lost certificates should be directed to: The East Carolina Bank P.O. Box 337 35080 US Highway 264 Engelhard, North Carolina 27824 Attention: Corporate Secretary INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS KPMG LLP Suite 1200, 150 Fayetteville Street Mall P.O. Box 29543 Raleigh, North Carolina 27626-0543 INVESTMENT BANKING ADVISOR Interstate/Johnson Lane Interstate Tower P.O. Box 1012 Charlotte, North Carolina 28201-1012 COUNSEL Davis & Davis Attorneys at Law P.O. Box 277 Swan Quarter, North Carolina 27885 BUSINESS PROFILE ECB Bancorp, Inc. ("Bancorp") is a bank holding company headquartered in Engelhard, North Carolina, whose wholly-owned subsidiary, The East Carolina Bank (the "Bank" or "ECB") (collectively referred to hereafter as the "Company"), is a state-chartered, independent, community bank founded in 1919. At year-end 1998, The East Carolina Bank had 131 full-time employees. ECB is a member of the Federal Deposit Insurance Corporation, the American Bankers Association, the North Carolina Bankers Association, and the Independent Bankers Association of America. The Bank currently operates 15 full-service branches, a loan production office and twelve automated teller machines in eastern North Carolina. Ten of these offices are located in mainland Beaufort, Currituck, Hyde, Pitt, Tyrrell, and Washington counties, and six are on North Carolina's famed Outer Banks, from Ocracoke Island in Hyde County to Southern Shores in Dare County. - - -------------------------------------------------------------------------------- Excellence in Community Banking 3 LETTER TO SHAREHOLDERS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries Dear Shareholder: This report represents the first annual report of ECB Bancorp, Inc., the new holding company for The East Carolina Bank. To that end, I am also pleased to announce that 1998 was another record-setting year. We continue to be blessed with a strong and diverse economy in our market area. This was once again displayed in 1998 even though we had to deal with hurricane Bonnie in addition to certain other adverse weather conditions for our agri-business segment. For the year ended December 31, 1998, Bancorp generated a consolidated net income of $1,959,000, or $1.08 per share, which is a 17.1% increase over the $1,673,000, or $.94 per share, earned for the period ended December 31, 1997. Consolidated total assets at year-end 1998 were $210,484,000, an 11.8% increase over total assets of $188,228,000 at December 31, 1997. Deposits of $184,185,000 represented a 7.8% increase over the previous year-end balance of $170,909,000. Loans grew 9.7% to $133,024,000 at December 31, 1998, up from $121,209,000 at December 31, 1997. Consolidated shareholders' equity for the period-end was $21,852,000, representing a 39.1% increase over the 1997 level. These financial results equate to a 1.01% return on average assets and an 11.33% return on average equity. 1998 was an exciting and event-filled year for your organization. Much of Senior Management's time in 1998 was devoted to several special projects. Not only was a holding company form of organization put in place, but the Directors also authorized a three-for-one stock split as a display of their confidence in the corporation's future. Both of these actions became effective July 22, 1998, and were matters that were approved for implementation at last year's shareholders' meeting. Moreover, in the fall of 1998, ECB Bancorp, Inc. undertook the sale of additional shares of common stock principally to support the continuation of its growth. We are gratified to report that the offering was over subscribed. Interstate/Johnson Lane Corporation served as underwriter for the offering and we are now listed on Nasdaq's SmallCap Market. For those of you who are first time shareholders, we welcome you to the family of ECB, Bancorp investors. The organization's overall performance in 1998 was also gratifying, particularly in light of certain increases in expenses associated with the expansion into new markets and the introduction of several new products. We are pleased to report that the new offices in Avon (Dare County) and Barco (Currituck County) continue to perform above expectations. The Bank's home mortgage products introduced earlier last year continue to progress well. To continue this momentum, a new Home Equity product line was introduced in March 1999 which we also anticipate will be a success. The construction of our new branch location in Manteo, (Dare County) is progressing nicely while in Washington, NC we are well underway in the completion of our 16th full service branch. We hope to open in late spring 1999 and eagerly look forward to bringing our form of community banking to the businesses and consumers of western Beaufort County. We have also announced the closing of our WalMart Branch (Greenville) after three years of effort to reach our goals. The Bank's valued employees and customers will be assigned to one of our other two Greenville locations. It goes without saying that your Directors and Senior Managers are dedicated to achieving ECB Bancorp's organizational goals of being a "Best Bank" and creating sustainable increases in shareholder value. To that end, we will continue to explore the addition of several new products including those relating to insurance and investment services as well as financial counseling. 1999 will also see a continuation of ECB Bancorp's firm commitment to both product and sales training so that we may continue to maintain our leadership position in each market for "quality customer service". Moreover, we will continue to explore creative uses of technology such as in check statement imaging and home banking via the Internet. - - -------------------------------------------------------------------------------- 4 LETTER TO SHAREHOLDERS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries Elsewhere in this report you will find a more detailed explanation of how ECB Bancorp is meeting the challenges surrounding the change in century. Suffice it to say, our "Year 2000" taskforce is tackling all issues, whether they be technical or psychological in nature. Managing the public's apprehension surrounding the "Y2K issue" will be a challenge for all financial institutions. As this effort continues through 1999, our staff will be conducting public seminars for both consumers and businesses with the goal of educating the audiences on how to manage a variety of "millennium" issues. You will be pleased to know that we have a very thorough contingency plan to deal with Y2K issues, including minor interruptions caused by the possible loss of electrical and telephone service. On the following page, you will find a photo of "The Newman's Own/George Award". In case you have not heard, The East Carolina Bank's philanthropic endeavors were nationally recognized at a dinner in New York in April 1998 hosted by Newman's Own/George Magazine. The Bank was a top ten finalist for the magazine's "Most Generous Company in America" award. By splitting our stock and issuing additional shares in 1998 (and becoming listed on Nasdaq's SmallCap Market), we believe we have created additional liquidity and visibility for ECB Bancorp investors. Commencing in 1999, it is our intent to pay dividends quarterly rather than once a year as we have done historically. These actions have been part of a plan designed to drive and create sustainable shareholder value. These initiatives will also assist in protecting the organization's ability to be both flexible and responsive to changing market and economic circumstances. The increased financial results that are being reported are a direct result of the organization's strategic initiatives formulated and implemented since 1996. In February 1999, the Board of Directors and the Senior Management team joined in a retreat to review and update where necessary the organization's current strategic plan. The conference was quite successful and the participants left confident that ECB Bancorp is facing the future in good order. We have received several requests to close this letter in the first annual report for ECB Bancorp, in the same manner as we have closed the Shareholders' letter for The East Carolina Bank over the last several years, so here goes. I would once again like to thank the Directors for their confidence and to acknowledge the continued display of teamwork throughout the organization, but particularly among the management team. Additionally, I will again thank the employees as I have all year long for their support and dedication to the principles upon which the success of this bank will be built. Lastly, I want to thank the shareholders for their support and patience as we put together a top-performing bank which will handsomely reward their investment over time. Sincerely, /s/ Arthur H. Keeney, III Arthur H. Keeney, III President & CEO March 29, 1999 - - -------------------------------------------------------------------------------- Excellence in Community Banking 5 [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries [LOGO] Excellence in Community Banking - - -------------------------------------------------------------------------------- 6 [PHOTO] "The Newman's Own George/Award" - - -------------------------------------------------------------------------------- Excellence in Community Banking 7 FINANCIAL HIGHLIGHTS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] RETURN ON ASSETS 1994 .82% 1995 .74% 1996 .80% 1998 1.01% 1997 .93% [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] RETURN ON EQUITY 1994 10.37% 1995 9.16% 1996 9.55% 1997 11.07% 1998 11.33% - - -------------------------------------------------------------------------------- 8 FINANCIAL HIGHLIGHTS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries
Percent 1998 1997 Change - - ------------------------------------------------------------------------------------------------- For the year: Operating income $ 16,909,358 $ 15,585,282 8.5% Operating expense 14,950,318 13,912,031 7.5% Net income 1,959,040 1,673,251 17.1% Per share amounts (basic and diluted) 1.08 .94 14.7% Cash dividends declared 453,965 415,393 9.3% Per share $ .255 $ .233 9.3% Average number of common shares outstanding 1,817,117 1,780,254 02.1% ================================================================= ============ ===== At year-end: Assets $210,483,738 $188,227,722 11.8% Earning assets 191,418,473 168,328,783 13.7% Loans 133,024,004 121,208,810 9.7% Investment securities 58,394,469 47,119,973 23.9% Allowance for possible loan losses 2,750,000 2,660,000 3.4% Deposits 184,184,803 170,908,861 7.8% Shareholders' equity 21,852,346 15,713,293 39.1% Book value per share $ 10.28 $ 8.83 16.5% ================================================================= ============ ===== Averages: Assets $194,618,000 $180,515,000 7.8% Earning assets 179,290,000 167,269,000 7.2% Loans 127,650,000 118,185,000 8.0% Deposits 175,857,000 164,363,000 7.0% Shareholders' equity 17,295,000 15,113,000 14.4%
[THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.]
Net Income 1998 $1,959,040 1997 $1,673,251 1996 $1,333,763 1994 $1,247,365 1995 $1,190,183
- - -------------------------------------------------------------------------------- Excellence in Community Banking 9 CONSOLIDATED FIVE YEAR FINANCIAL SUMMARY [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries
ASSETS AND LIABILITIES 1998 1997 1996 1995 1994 - - -------------------------------------------------------------- ------------ ------------ ------------ -------------- Deposits $184,184,803 $170,908,861 $151,335,562 $150,435,845 $141,044,393 Demand 86,197,280 73,153,398 66,263,148 61,617,488 62,631,974 Savings and time 97,987,523 97,755,463 85,072,414 88,818,357 78,412,419 Loans 133,024,004 121,208,810 112,655,981 94,488,919 85,997,184 Securities: 58,394,469 47,119,973 34,588,505 47,771,754 51,160,625 Taxable 41,527,347 33,062,817 25,334,366 38,259,514 41,834,692 Tax exempt 16,867,122 14,057,156 9,254,139 9,512,240 9,325,933 Allowance for possible loan losses 2,750,000 2,660,000 2,400,000 1,950,000 1,900,000 Shareholders' equity 21,852,346 15,713,293 14,249,546 13,426,644 11,904,174 Assets $210,483,738 $188,227,722 $167,217,594 $165,407,814 $153,552,839 ============================================================== ============ ============ ============ ============== OPERATING SUMMARY Interest income: Interest and fees on loans $ 12,014,838 $ 10,887,327 $ 9,521,265 $ 8,754,549 $ 7,237,495 Interest on securities 2,625,600 2,261,265 2,390,995 2,677,175 2,488,626 Interest on federal funds sold 241,595 490,623 301,265 371,806 188,251 - - -------------------------------------------------------------- ------------ ------------ ------------ -------------- Total interest income 14,882,033 13,639,215 12,213,525 11,803,530 9,914,372 - - -------------------------------------------------------------- ------------ ------------ ------------ -------------- Interest expense: Interest on deposits 5,351,026 5,363,757 4,831,397 5,207,179 3,560,886 Interest on borrowed money 8,853 786 9,459 8,746 3,261 - - -------------------------------------------------------------- ------------ ------------ ------------ -------------- Total interest expense 5,359,879 5,364,543 4,840,856 5,215,925 3,564,147 - - -------------------------------------------------------------- ------------ ------------ ------------ -------------- Net interest income 9,522,154 8,274,672 7,372,669 6,587,605 6,350,225 Provision for possible loan losses 242,396 353,513 496,914 515,066 396,926 Non-interest income 2,027,325 1,946,067 1,718,064 1,669,518 1,580,990 Non-interest expenses 8,703,043 7,543,975 6,785,056 6,167,874 5,786,924 - - -------------------------------------------------------------- ------------ ------------ ------------ -------------- Income before taxes and cumulative effect of a change in accounting for postretirement benefits 2,604,040 2,323,251 1,808,763 1,574,183 1,747,365 Income taxes 645,000 650,000 475,000 384,000 500,000 - - -------------------------------------------------------------- ------------ ------------ ------------ -------------- Income before cumulative effect of a change in accounting for postretirement benefits 1,959,040 1,673,251 1,333,763 1,190,183 1,247,365 - - -------------------------------------------------------------- ------------ ------------ ------------ -------------- Cumulative effect for years prior to January 1, 1995 of a change in accounting for postretirement benefits, net of income tax -- -- -- (278,555) -- - - -------------------------------------------------------------- ------------ ------------ ------------ -------------- Net income $ 1,959,040 $ 1,673,251 $ 1,333,763 $ 911,628 $ 1,247,365 ============================================================== ============ ============ ============ ============== Weighted average outstanding shares of common stock 1,817,117 1,780,254 1,780,254 1,780,254 1,780,254 Per share amounts: Income before cumulative effect of a change in accounting for postretirement benefits $ 1.08 $ 0.94 $ 0.75 $ 0.67 $ 0.70 Cumulative effect for years prior to January 1, 1995 of a change in accounting for postretirement benefits -- -- -- (0.16) -- - - -------------------------------------------------------------- ------------ ------------ ------------ -------------- Net income per common share (basic and diluted) $ 1.08 $ .94 $ .75 $ .51 $ .70 ============================================================== ============ ============ ============ ==============
- - -------------------------------------------------------------------------------- 10 INDEPENDENT AUDITORS' REPORT - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries INDEPENDENT AUDITORS' REPORT THE BOARD OF DIRECTORS ECB BANCORP, INC.: We have audited the accompanying consolidated balance sheets of ECB Bancorp, Inc. and subsidiary (the "Company") as of December 31, 1998 and 1997, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ECB Bancorp, Inc. and subsidiary as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. KPMG LLP Raleigh, North Carolina February 5, 1999 - - -------------------------------------------------------------------------------- Excellence in Community Banking 11 CONSOLIDATED BALANCE SHEETS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries
December 31, 1998 and 1997 Assets 1998 1997 - - ------------------------------------------------------------------------------------------------------------- ------------- Non-interest bearing deposits and cash (note 13) $ 11,786,543 $ 8,280,694 Federal funds sold -- 4,425,000 - - ------------------------------------------------------------------------------------------------------------- ------------- Total cash and cash equivalents 11,786,543 12,705,694 - - ------------------------------------------------------------------------------------------------------------- ------------- Investment securities (note 2): Available-for-sale (cost: $57,374,975 and $46,655,155, respectively) 58,394,469 47,119,973 Loans (note 3) 133,024,004 121,208,810 Allowance for possible loan losses (note 4) (2,750,000) (2,660,000) - - ------------------------------------------------------------------------------------------------------------- ------------- Loans, net 130,274,004 118,548,810 - - ------------------------------------------------------------------------------------------------------------- ------------- Real estate acquired in settlement of loans, net 50,000 340,000 Real estate held for sale, net -- 150,000 Federal Home Loan Bank common stock, at cost 564,800 503,000 Bank premises and equipment, net (note 5) 7,006,508 6,266,283 Accrued interest receivable 2,096,424 1,922,814 Other assets (note 6) 310,990 671,148 - - ------------------------------------------------------------------------------------------------------------- ------------- Total $ 210,483,738 $ 188,227,722 ============================================================================================================= ============= Liabilities and Shareholders' Equity - - ------------------------------------------------------------------------------------------------------------- ------------- Deposits (note 10): Demand, noninterest bearing $ 38,086,062 $ 31,897,001 Demand, interest bearing 48,111,218 41,256,397 Savings 14,561,072 14,712,835 Time 83,426,451 83,042,628 - - ------------------------------------------------------------------------------------------------------------- ------------- Total deposits 184,184,803 170,908,861 - - ------------------------------------------------------------------------------------------------------------- ------------- Federal funds purchased 2,725,000 -- Accrued interest payable 829,104 698,997 Other liabilities (note 7) 892,485 906,571 - - ------------------------------------------------------------------------------------------------------------- ------------- Total liabilities 188,631,392 172,514,429 - - ------------------------------------------------------------------------------------------------------------- ------------- Shareholders' equity (notes 11, 13 and 16): Common stock, par value $3.50 per share; authorized 10,000,000 shares; issued and outstanding 2,125,254 and 1,780,254 shares at December 31, 1998 and 1997, respectively 7,438,389 6,230,889 Capital surplus 6,260,392 3,200,000 Retained earnings 7,480,699 5,975,624 Accumulated other comprehensive income 672,866 306,780 - - ------------------------------------------------------------------------------------------------------------- ------------- Total shareholders' equity 21,852,346 15,713,293 - - ------------------------------------------------------------------------------------------------------------- ------------- Commitments and contingencies (notes 12 and 14) Total $ 210,483,738 $ 188,227,722 ============================================================================================================= =============
- - -------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements. 12 CONSOLIDATED STATEMENTS OF INCOME - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries
Years ended December 31, 1998, 1997 and 1996 1998 1997 1996 - - ------------------------------------------------------------------------------------ ----------- ----------- ----------- Interest income: Interest and fees on loans $12,014,838 $10,887,327 $ 9,521,265 Interest on investment securities: Interest exempt from federal income taxes 751,990 511,653 472,206 Taxable interest income 1,873,610 1,749,612 1,918,789 Interest on federal funds sold 241,595 490,623 301,265 - - ------------------------------------------------------------------------------------ ----------- ----------- ----------- Total interest income 14,882,033 13,639,215 12,213,525 - - ------------------------------------------------------------------------------------ ----------- ----------- ----------- Interest expense: Deposits (note 10): Demand accounts 686,085 698,635 699,138 Savings 284,094 308,012 328,029 Time 4,380,847 4,357,110 3,804,230 Other 8,853 786 9,459 - - ------------------------------------------------------------------------------------ ----------- ----------- ----------- Total interest expense 5,359,879 5,364,543 4,840,856 - - ------------------------------------------------------------------------------------ ----------- ----------- ----------- Net interest income 9,522,154 8,274,672 7,372,669 Provision for possible loan losses (note 4) 242,396 353,513 496,914 - - ------------------------------------------------------------------------------------ ----------- ----------- ----------- Net interest income after provision for possible loan losses 9,279,758 7,921,159 6,875,755 - - ------------------------------------------------------------------------------------ ----------- ----------- ----------- Non-interest income: Service charges on deposit accounts 1,334,958 1,391,136 1,102,866 Other service charges and fees 590,832 524,638 419,128 Net gain on sale of securities -- -- 5,662 Net gain on sale of real estate acquired in settlement of loans and real estate held for sale -- -- 110,960 Other 101,535 30,293 79,448 - - ------------------------------------------------------------------------------------ ----------- ----------- ----------- Total non-interest income 2,027,325 1,946,067 1,718,064 - - ------------------------------------------------------------------------------------ ----------- ----------- ----------- Non-interest expense: Salaries 3,186,103 2,938,570 2,770,184 Retirement and other employee benefits (note 7) 1,083,843 971,474 939,505 Occupancy 720,257 623,134 549,613 Equipment 875,232 768,244 563,478 Deposit insurance premiums 20,532 24,589 1,500 Professional fees 318,336 209,038 198,298 Supplies 251,076 221,978 183,942 Telephone 265,386 216,821 176,034 Postage 171,747 150,311 143,458 Other 1,810,531 1,419,816 1,259,044 - - ------------------------------------------------------------------------------------ ----------- ----------- ----------- Total non-interest expense 8,703,043 7,543,975 6,785,056 - - ------------------------------------------------------------------------------------ ----------- ----------- ----------- Income before income taxes 2,604,040 2,323,251 1,808,763 Income taxes (note 6) 645,000 650,000 475,000 - - ------------------------------------------------------------------------------------ ----------- ----------- ----------- Net income $ 1,959,040 $ 1,673,251 $ 1,333,763 ==================================================================================== =========== =========== =========== Net income per share (basic and diluted) $ 1.08 $ 0.94 $ 0.75 Weighted average common shares outstanding 1,817,117 1,780,254 1,780,254 ==================================================================================== =========== =========== ===========
See accompanying notes to consolidated financial statements. - - -------------------------------------------------------------------------------- 13 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries
Years ended December 31, 1998, 1997 and 1996 Common stock Accumulated --------------------------- other Number Capital Retained comprehensive of shares Amount surplus earnings income - - ------------------------------------- ------------ ------------ ------------ ------------ ------------ Balance at December 31, 1995 (note 11) 1,780,254 $ 6,230,889 $ 3,200,000 $ 3,763,791 $ 231,964 Unrealized losses, net of income taxes of $67,500 -- -- -- -- (131,073) Net income -- -- -- 1,333,763 -- Total comprehensive income Cash dividends ($.21 per share) -- -- -- (379,788) -- - - ------------------------------------- ------------ ------------ ------------ ------------ ------------ Balance at December 31, 1996 1,780,254 6,230,889 3,200,000 4,717,766 100,891 Unrealized gains, net of income taxes of $106,000 -- -- -- -- 205,889 Net income -- -- -- 1,673,251 -- Total comprehensive income Cash dividends ($.23 per share) -- -- -- (415,393) -- - - ------------------------------------- ------------ ------------ ------------ ------------ ------------ Balance at December 31, 1997 1,780,254 6,230,889 3,200,000 5,975,624 306,780 Unrealized gains, net of income taxes of $188,590 -- -- -- -- 366,086 Net income -- -- -- 1,959,040 -- Total comprehensive income Common stock issued (note 11) 345,000 1,207,500 3,060,392 -- -- Cash dividends ($.255 per share) -- -- -- (453,965) -- - - ------------------------------------- ------------ ------------ ------------ ------------ ------------ Balance at December 31, 1998 2,125,254 $ 7,438,389 $ 6,260,392 $ 7,480,699 $ 672,866 ===================================== ============ ============ ============ ============ ============
Comprehensive income Total - - ------------------------------------- ------------ ------------ Balance at December 31, 1995 (note 11) $ 13,426,644 Unrealized losses, net of income taxes of $67,500 (131,073) (131,073) Net income 1,333,763 1,333,763 Total comprehensive income $ 1,202,690 ============ Cash dividends ($.21 per share) (379,788) - - ------------------------------------- ------------ ------------ Balance at December 31, 1996 14,249,546 Unrealized gains, net of income taxes of $106,000 205,889 205,889 Net income 1,673,251 1,673,251 Total comprehensive income $ 1,879,140 ============ Cash dividends ($.23 per share) (415,393) - - ------------------------------------- ------------ ------------ Balance at December 31, 1997 15,713,293 Unrealized gains, net of income taxes of $188,590 366,086 366,086 Net income 1,959,040 1,959,040 ------------ Total comprehensive income $ 2,325,126 ============ Common stock issued (note 11) 4,267,892 Cash dividends ($.255 per share) (453,965) - - ------------------------------------- ------------ ------------ Balance at December 31, 1998 $ 21,852,346 ===================================== ============
See accompanying notes to consolidated financial statements. 14 CONSOLIDATED STATEMENTS OF CASH FLOWS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries
Years ended December 31, 1998, 1997 and 1996 1998 1997 1996 - - -------------------------------------------------------------------------------- ------------ ------------ ------------ Cash flows from operating activities: Net income $ 1,959,040 $ 1,673,251 $ 1,333,763 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 668,383 545,852 445,314 Amortization of premium on investment securities, net 54,862 51,838 9,870 Provision for possible loan losses 242,396 353,513 496,914 Provision for loss on real estate held for sale -- 50,000 53,800 Deferred income taxes 72,000 (33,700) (128,500) Loss (gain) on sale of available-for-sale securities -- 25,818 (5,662) Loss (gain) on sale of real estate acquired in settlement of loans and real estate held for sale (6,476) 95 (110,960) Loss on disposal of premises and equipment 6,285 7,242 8,384 Increase in accrued interest receivable (173,610) (403,494) (74,499) Decrease (increase) in other assets 99,568 (914) (8,989) Increase (decrease) in accrued interest payable 130,107 115,265 (72,264) Increase in postretirement benefit liability 20,747 42,000 28,000 Increase (decrease) in other liabilities (34,833) (184,183) 106,518 - - -------------------------------------------------------------------------------- ------------ ------------ ------------ Net cash provided by operating activities 3,038,469 2,242,583 2,081,689 - - -------------------------------------------------------------------------------- ------------ ------------ ------------ Cash flows from investing activities: Proceeds from sales of investment securities classified as available-for-sale -- 3,015,439 513,924 Proceeds from maturities of investment securities classified as available-for-sale 9,913,543 13,349,710 21,500,092 Purchases of investment securities classified as available-for-sale (20,688,225) (28,662,322) (9,033,608) Purchases of Federal Home Loan Bank common stock (61,800) (503,000) -- Proceeds from disposal of premises and equipment 12,063 23,665 21,842 Purchases of premises and equipment (1,426,956) (1,304,813) (592,433) Proceeds from disposal of real estate acquired in settlement of loans and real estate held for sale 446,476 50,263 406,653 Net loan originations (11,967,590) (9,075,362) (18,146,433) - - -------------------------------------------------------------------------------- ------------ ------------ ------------ Net cash used by investing activities (23,772,489) (23,106,420) (5,329,963) - - -------------------------------------------------------------------------------- ------------ ------------ ------------ Cash flows from financing activities: Net increase in deposits 13,275,942 19,573,299 924,642 Net increase in federal funds purchased 2,725,000 -- -- Dividends paid (453,965) (415,393) (379,788) Proceeds from issuance of common stock 4,267,892 -- -- - - -------------------------------------------------------------------------------- ------------ ------------ ------------ Net cash provided by financing activities 19,814,869 19,157,906 544,854 - - -------------------------------------------------------------------------------- ------------ ------------ ------------ Decrease in cash and cash equivalents (919,151) (1,705,931) (2,703,420) Cash and cash equivalents at beginning of year 12,705,694 14,411,625 17,115,045 - - -------------------------------------------------------------------------------- ------------ ------------ ------------ Cash and cash equivalents at end of year $ 11,786,543 $ 12,705,694 $ 14,411,625 ================================================================================ ============ ============ ============ Supplemental disclosure of noncash financing and investing activities: Unrealized gains (losses) on available-for-sale securities, net of deferred taxes $ 366,086 $ 205,889 $ (131,073) ================================================================================ ============ ============ ============
See accompanying notes to consolidated financial statements. - - -------------------------------------------------------------------------------- Excellence in Community Banking 15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries December 31, 1998 and 1997 (1) Summary of Significant Accounting and Reporting Policies (a) Consolidation The consolidated financial statements include the accounts of ECB bancorp, Inc. ("Bancorp") (see note 11) and its wholly-owned subsidiary, The East Carolina Bank (the "Bank") (collectively referred to hereafter as the "Company"). The Bank has two wholly-owned subsidiaries, Carolina Financial Realty, Inc. and Carolina Financial Courier, Inc. Significant intercompany accounts and transactions have been eliminated in consolidation. (b) Basis of Financial Statement Presentation The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheets and the reported amounts of income and expenses for the periods presented. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for possible loan losses. In connection with the determination of the allowance for possible loan losses, management obtains independent appraisals for significant properties held as collateral for loans. (c) Business Bancorp is a bank holding company incorporated in North Carolina. The principal activity of Bancorp is ownership of the Bank. The Bank provides financial services through its branch network located in eastern North Carolina. The Bank competes with other financial institutions and numerous other non-financial services commercial entities offering financial services products. The Bank is further subject to the regulations of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities. The Company has no foreign operations, and the Company's customers are principally located in eastern North Carolina. (d) Cash and Cash Equivalents Cash and cash equivalents include demand and time deposits (with original maturities of ninety days or less) at other financial institutions and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. (e) Investment Securities Management determines the appropriate classification of investment securities at the time of purchase and reevaluates such designation at each reporting date. Securities are classified as held-to-maturity ("HTM") when the Company has both the positive intent and ability to hold the securities to maturity. HTM securities are stated at amortized cost. Securities not classified as HTM are classified as available-for-sale ("AFS"). AFS securities are stated at fair value as determined by reference to published sources, with the unrealized gains and losses, net of income taxes, reported as a separate component of shareholders' equity. The Company has no trading securities. The amortized cost of securities classified as HTM or AFS is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income from investments. Realized gains and losses, and declines in value judged to be other-than-temporary are included in net securities gains (losses). The cost of securities sold is based on the specific identification method. (f) Loans Receivable Loans are generally stated at their outstanding unpaid principal balances net of any deferred fees or costs. Loan origination fees net of certain direct loan origination costs are deferred and amortized as a yield adjustment over the contractual life of the related loans using the level-yield method. - - -------------------------------------------------------------------------------- 16 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries (1) Summary of Significant Accounting and Reporting Policies (continued) Interest on loans is recorded based on the principal amount outstanding. The Company ceases accruing interest on loans (including impaired loans) when, in management's judgment, the collection of interest income appears doubtful or the loan is past due 90 days or more. Management may return a loan classified as nonaccrual to accrual status when the obligation has been brought current, has performed in accordance with its contractual terms over an extended period of time, and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. (g) Allowance for Possible Loan Losses The allowance for possible loan losses ("AFLL") is established through provisions for losses charged against income. Loan amounts deemed to be uncollectible are charged against the AFLL, and subsequent recoveries, if any, are credited to the allowance. The AFLL represents management's estimate of the amount necessary to absorb estimated probable losses existing in the loan portfolio. Management believes that the AFLL is adequate. Management's periodic evaluation of the adequacy of the allowance is based on individual loan reviews, past loan loss experience, economic conditions in the Company's market areas, the fair value and adequacy of underlying collateral, and the growth and risk composition of the loan portfolio. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans, that may be susceptible to significant change. Thus, future additions to the AFLL may be necessary based on the impact of changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's AFLL. Such agencies may require the Company to recognize additions to the AFLLbased on their judgments about information available to them at the time of their examination. Under the provisions of Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan Income Recognition and Disclosures" (collectively referred to hereafter as "SFAS No. 114"), the AFLL related to loans that are identified for evaluation in accordance with these standards is based on discounted cash flows using the loan's initial effective interest rate, the loan's observable market price, or the fair value of the collateral for collateral dependent loans. (h) Real Estate Acquired in Settlement of Loans Real estate acquired in settlement of loans consists of property acquired through a foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure and loans classified as in-substance foreclosure. In accordance with SFAS No. 114, a loan is classified as in-substance foreclosure when the Company has taken possession of the collateral regardless of whether formal foreclosure proceedings have taken place. Real estate acquired in settlement of loans is recorded initially at the lower of the loan balance plus unpaid accrued interest or estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charged to earnings, if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Costs related to the improvement of the property are capitalized, whereas those related to holding the property are expensed. Such properties are held for sale and, accordingly, no depreciation or amortization expense is recognized. Loans with outstanding principal balances totalling $390,358 were foreclosed on during the years ended December 31, 1997. There were such foreclosures in 1998 or 1996. (i) Membership/Investment in Federal Home Loan Bank Stock In 1997, the Company became a member of the Federal Home Loan Bank of Atlanta ("FHLB"). Membership, along with a signed blanket collateral agreement, provides the Company with the ability to draw $13 million of advances from the FHLB. No advances were drawn by the Company in 1998 or 1997. As a requirement for membership, the Company invests in stock of the FHLB in the amount of 1% of its outstanding residential loans or 5% of its outstanding advances from the FHLB, whichever is greater. Such stock is pledged as collateral for any FHLB advances drawn by the Company. At December 31, 1998, the Company owned 5,648 shares of the FHLB's $100 par value capital stock. No ready market exists for such stock, which is carried at cost. - - -------------------------------------------------------------------------------- Excellence in Community Banking 17 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries (1) Summary of Significant Accounting and Reporting Policies (continued) (j) Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed by the straight-line method and is charged to operations over the estimated useful lives of the assets which range from 25 to 50 years for bank premises and 3 to 10 years for furniture and equipment. Maintenance, repairs, renewals and minor improvements are charged to expense as incurred. Major improvements are capitalized and depreciated. (k) Income Taxes The Company records income taxes using the asset and liability method. Under this method, deferred income taxes are determined based on temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates expected to be in effect when such amounts are realized or settled. (l) Employee Benefit Plans The Company has in place a postretirement benefit plan covering certain retirees and a defined contribution 401(k) plan that covers all eligible employees. The Company had a noncontributory defined benefit retirement plan that covered substantially all employees which was terminated in 1995 with final pay-out of accrued benefits occurring in 1996 (see note 7). (m) Stock Option Plan As discussed in note 8, the Company adopted a stock option plan in 1998. The Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board Opinion No. 25 (APB Opinion No. 25), "Accounting for Stock Issued to Employees," and related interpretations. As such, compensation expense is recorded on the date of grant only if the market price of the underlying stock on the date of grant exceeds the exercise price. SFAS No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123), requires entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to apply the provisions of ABP Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. (n) Net Income/Dividends Per Share The Company adopted SFAS No. 128, "Earnings Per Share" (SFAS No. 128) as of December 31, 1997. SFAS No. 128 superseded Accounting Principles Board Opinion No. 15, "Earnings Per Share" (APB No. 15) which the Company had followed until the adoption of SFAS No. 128. For companies that have potentially issuable stock (complex capital structures), such as Bancorp with its stock option plan, SFAS No. 128 requires that two earnings per share amounts be disclosed - 1) Basic Earnings Per Share and 2) Diluted Earnings per Share. Basic Earnings Per Share is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Diluted Earnings Per Share is computed by assuming the issuance of common shares for all dilutive potential common shares outstanding during the reporting period. Currently, the Company's only dilutive potential common stock issuances relate to options that have been issued under the Company's stock option plan. In computing Diluted Earnings Per Share, it is assumed that all such dilutive stock options are exercised during the reporting period at their respective exercise prices, with the proceeds from the exercises used by the Company to buy back stock in the open market at the average market price in effect during the reporting period. The difference between the number of shares assumed to be exercised and the - - -------------------------------------------------------------------------------- 18 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries (1) Summary of Significant Accounting and Reporting Policies (continued) number of shares bought back is added to the number of weighted average common shares outstanding during the period. The sum is used as the denominator to calculate Diluted Earnings Per Share for the Company. Dividends per share are based on the shares outstanding at the time of dividend declaration. All shares and per share amounts have been restated to give effect to the three-for-one stock split on July 22, 1998 (see note 11). (o) Comprehensive Income On January 1, 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting and display of comprehensive income and its components in a full set of financial statements. Comprehensive income is defined as the change in equity during a period for non-owner transactions and is divided into net income and other comprehensive income. Other comprehensive income includes revenues, expenses, gains, and losses that are excluded from earnings under current accounting standards. This statement does not change or modify the reporting or display in the income statement. As of and for the periods presented, the sole component of other comprehensive income for the Company has consisted of unrealized gains and losses, net of taxes, of the Company's available-for-sale securities portfolio. Comparative financial statements for earlier periods have been presented to reflect application of this statement. During 1997 the net tax effect of $106,000 on unrealized gains was net of a reclassification adjustment of $8,778 for losses on sales of available-for-sale securities included in net income. During 1996 the net tax effect of $67,500 on unrealized losses was net of a reclassification adjustment of $1,925 for gains on sales of available-for-sale securities included in net income. (p) Segment Reporting In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 requires that public business enterprises report certain information about operating segments in complete sets of financial statements issued to shareholders. It also requires that public business enterprises report certain information about their products and services, the geographic areas in which they operate and their major customers. The provisions of SFAS No. 131 are effective for fiscal years beginning after December 15, 1997. Adoption of this pronouncement had no effect on the Company's consolidated financial statements as the Company has no operating segments as defined by SFAS No. 131. (q) Disclosures About Pensions In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and other Postretirement Benefits," ("SFAS No. 132"). This statement standardizes the disclosure requirements of pensions and other postretirement benefits. Adoption of SFAS No. 132 by the Company did not result in changes to any measurement or recognition provisions, but has resulted in altered disclosures relating to postretirement obligations. (r) Reclassifications Certain 1996 and 1997 amounts have been reclassified in the financial statements to conform with the 1998 presentation. The reclassifications had no effect on previously reported net income or retained earnings. - - -------------------------------------------------------------------------------- Excellence in Community Banking 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries (2) Investment Securities The following is a summary of the securities portfolios by major classification:
December 31, 1998 - - ------------------------------------------------------------------------------------------------------------------------------------ Gross Gross Amortized unrealized unrealized Fair cost gains losses value - - ------------------------------------------------------------------------------------------------------------------------------------ Securities available-for-sale: U.S. Treasury obligations $19,045,593 $ 406,297 $ -- $19,451,890 Securities of other U.S. government agencies and corporations 20,913,647 70,740 (21,802) 20,962,585 Obligations of states and political subdivisions 16,867,122 563,438 (5,236) 17,425,324 Mortgage-backed securities 548,613 6,057 -- 554,670 - - ------------------------------------------------------------------------------- ----------- ----------- ----------- Total $57,374,975 $ 1,046,532 $ (27,038) $58,394,469 =============================================================================== =========== =========== ===========
December 31, 1997 - - ------------------------------------------------------------------------------------------------------------------------------------ Securities available-for-sale: U.S. Treasury obligations $25,072,694 $ 156,543 $ (1,087) $25,228,150 Securities of other U.S. government agencies and corporations 7,041,372 12,509 (2,427) 7,051,454 Obligations of states and political subdivisions 13,761,077 300,592 (4,513) 14,057,156 Mortgage-backed securities 780,012 3,201 -- 783,213 - - ------------------------------------------------------------------------------- ----------- ----------- ----------- Total $46,655,155 $ 472,845 $ (8,027) $47,119,973 =============================================================================== =========== =========== ===========
Gross realized gains and losses on sales of securities for the years ended December 31, 1998, 1997 and 1996 were as follows:
1998 1997 1996 - - ------------------------------------------------------------------------------- ----------- ----------- Gross realized gains $ -- $ -- $ 5,662 Gross realized losses -- (25,818) -- - - ------------------------------------------------------------------------------- ----------- ----------- Net realized gains (losses) $ -- $ (25,818) $ 5,662 ==================================================================================================================
The aggregate amortized cost and fair value of the available-for-sale securities portfolio at December 31, 1998, by remaining contractual maturity are as follows:
Amortized Fair cost value - - ------------------------------------------------------------------------------------------------------------------------------------ U.S. Treasury obligations: Due in one year or less $ 6,002,110 $ 6,024,060 Due in one year through five years 13,043,483 13,427,830 Securities of other U.S. government agencies and corporations: Due in one year or less 8,670,009 8,665,716 Due in one year through five years 12,243,638 12,296,869 Obligations of states and political subdivisions: Due in one year or less 1,245,276 1,248,865 Due in one year through five years 4,601,221 4,742,142 Due after five through ten years 6,329,528 6,522,994 Due after ten years 4,691,097 4,911,323 Mortgage-backed securities 548,613 554,670 - - ------------------------------------------------------------------------------------------------------------- ----------- Total securities $57,374,975 $58,394,469 ============================================================================================================= ===========
Securities with a principal amount of approximately $22,620,000 at December 31, 1998 are pledged as collateral for deposits. - - -------------------------------------------------------------------------------- 20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries (3) Loans Loans at December 31, 1998 and 1997 classified by type, are as follows:
1998 1997 - - -------------------------------------------------------------------------------------------- ------------ Commercial, financial and agricultural $ 48,893,329 $ 27,580,080 Real estate loans: Construction 4,560,418 1,490,215 Mortgage, commercial and residential 64,687,018 63,444,502 Installment 15,033,205 28,838,515 - - -------------------------------------------------------------------------------------------- ------------ 133,173,970 121,353,312 Less deferred fees and costs, net 149,966 144,502 - - -------------------------------------------------------------------------------------------- ------------ $133,024,004 $121,208,810 ============================================================================================ ============ Included in the above: Nonaccrual loans $ 88,170 $ 1,462,831 Restructured loans $ 620,612 $ 522,352 ============================================================================================ ============
In 1998 the Company reclassified loans according to purpose rather than collateral type. The effect was a shifting of loans from Installment to Commerical. The Company did not have the information needed to reclassify 1997 loans to conform to the current year classifications. At December 31, 1998, the recorded investment in loans that are considered to be impaired under SFAS No. 114 was $46,000 (all on a non-accrual basis), the entire balance of which has been reserved in the AFLL. The average recorded investment in impaired loans during the year ended December 31, 1998 was approximately $354,000. For the year ended December 31, 1998, the Company recognized interest income on those impaired loans of $234,683, all of which was recognized using the cash basis method of income recognition. At December 31, 1997, the recorded investment in loans that are considered to be impaired under SFAS No. 114 was $797,000 (all on a non-accrual basis). Included in this amount is $112,000 of impaired loans for which the related AFLL is $112,000 and $685,000 of impaired loans that as a result of write-downs and collateral values do not have an AFLL. The average recorded investment in impaired loans during the year ended December 31, 1997 was approximately $810,000. For the year ended December 31, 1997, the Company recognized interest income on those impaired loans of $26,000, all of which was recognized using the cash basis method of income recognition. Interest income that would have been recorded on nonaccrual loans for the years ended December 31, 1998, 1997 and 1996 had they performed in accordance with the original terms throughout each of the periods amounted to approximately $3,147, $161,000, and $119,000, respectively. Actual interest income recorded on nonaccrual loans for the years ended December 31, 1998, 1997 and 1996 was $274,000, $25,000 and $23,000, respectively. Interest income on restructured loans included in the results of operations for each of the years amounted to approximately $57,000, $53,000 and $41,000, respectively. Loans at December 31, 1998 and 1997 include loans to officers and directors and their associates totaling approximately $800,000 and $1,103,000, respectively. During 1998, $431,000 in loans were disbursed to officers, directors and their associates and principal repayments of $734,000 were received on such loans. The Company, through its normal lending activity, originates and maintains loans receivable which are substantially concentrated in the Eastern region of North Carolina, where its offices are located. The Company's policy calls for collateral or other forms of repayment assurance to be received from the borrower at the time of loan origination. Such collateral or other form of repayment assurance is subject to changes in economic value due to various factors beyond the control of the Company and such changes could be significant. At December 31, 1998 and 1997, included in mortgage, commercial and residential loans were loans collateralized by owner-occupied residential real estate of approximately $21,152,000 and $23,963,000, respectively. - - -------------------------------------------------------------------------------- Excellence in Community Banking 21 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries (4) Allowance for Possible Loan Losses An analysis of the allowance for possible loan losses for the years ended December 31, 1998, 1997 and 1996 follows:
December 31, - - ------------------------------------------------------------------------------------------------------------------------------------ 1998 1997 1996 - - --------------------------------------------------------------------------------- ------------ ------------- Beginning balance $ 2,660,000 $ 2,400,000 $ 1,950,000 Provision for possible loan losses 242,396 353,513 496,914 Recoveries 78,538 100,838 218,843 Loans charged off (230,934) (194,351) (265,757) - - --------------------------------------------------------------------------------- ------------ ------------- Ending balance $ 2,750,000 $ 2,660,000 $ 2,400,000 ================================================================================= ============ =============
(5) Premises and Equipment An analysis of premises and equipment at December 31, 1998 and 1997 follows:
Accumulated Undepreciated Cost depreciation cost - - --------------------------------------------------------------------------------- ------------ ------------- December 31, 1998: Land $ 1,787,138 $ -- $ 1,787,138 Land improvements 242,744 179,286 63,458 Buildings 5,599,256 1,739,986 3,859,270 Furniture and equipment 4,594,566 3,297,924 1,296,642 - - --------------------------------------------------------------------------------- ------------ ------------- Total $ 12,223,704 $ 5,217,196 $ 7,006,508 ================================================================================= ============ ============= December 31, 1997: Land $ 1,177,138 $ -- $ 1,177,138 Land improvements 243,541 161,959 81,582 Buildings 5,270,762 1,535,891 3,734,871 Furniture and equipment 4,201,127 2,928,435 1,272,692 - - --------------------------------------------------------------------------------- ------------ ------------- Total $ 10,892,568 $ 4,626,285 $ 6,266,283 ================================================================================= ============ =============
(6) Income Taxes The components of income tax expense (benefit) are as follows:
Current Deferred Total - - --------------------------------------------------------------------------------- ------------ ------------- Year ended December 31, 1998: Federal $ 556,700 $ 72,000 $ 628,700 State 16,300 -- 16,300 ================================================================================= ============ ============= $ 573,000 $ 72,000 $ 645,000 ================================================================================= ============ ============= Year ended December 31, 1997: Federal $ 660,700 $ (33,700) $ 627,000 State 23,000 -- 23,000 - - --------------------------------------------------------------------------------- ------------ ------------- $ 683,700 $ (33,700) $ 650,000 ================================================================================= ============ ============= Year ended December 31, 1996: Federal $ 599,500 $ (128,500) $ 471,000 State 4,000 -- 4,000 - - --------------------------------------------------------------------------------- ------------ ------------- $ 603,500 $ (128,500) $ 475,000 ================================================================================= ============ =============
- - -------------------------------------------------------------------------------- 22 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries (6) Income Taxes (continued) Total income tax expense was less than the amount computed by applying the federal income tax rate of 34% to income before income taxes. The reasons for the difference were as follows:
Year Ended December 31, - - ----------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - - -------------------------------------------------------------------------------- --------- ---------- Income taxes at statutory rate $ 885,000 $ 790,000 $ 615,000 Increase (decrease) resulting from: Effect of non-taxable interest income (268,000) (187,000) (179,000) Other, net 28,000 47,000 39,000 - - -------------------------------------------------------------------------------- --------- ---------- Applicable income taxes $ 645,000 $ 650,000 $ 475,000 ================================================================================ ========= ==========
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998 and 1997 are presented below:
1998 1997 - - ---------------------------------------------------------------------------------------------------------- --------- Deferred tax assets: Allowance for possible loan losses $710,600 $680,000 Writedown of other real estate -- 78,000 Postretirement benefits 183,500 175,300 Other 3,700 3,200 - - ---------------------------------------------------------------------------------------------------------- --------- Total gross deferred tax assets $897,800 $936,500 ========================================================================================================== ========= Deferred tax liabilities: Bank premises and equipment, principally due to differences in depreciation $280,800 $245,400 Unrealized holding gains on securities available for sale 347,000 158,000 Other 30,900 22,000 - - ---------------------------------------------------------------------------------------------------------- --------- Total gross deferred tax liabilities 658,700 425,400 - - ---------------------------------------------------------------------------------------------------------- --------- Net deferred tax asset $239,100 $511,100 ========================================================================================================== =========
The Company has no valuation allowance at December 31, 1998 or 1997, because management has determined that it has sufficient taxable income in the carryback period to support the realizability of the net deferred tax asset. Income taxes paid during each of the three years ended December 31, 1998, 1997 and 1996 were $555,700, $749,400 and $534,100, respectively. (7) Retirement Plans and Other Postretirement Benefits Net periodic pension cost for 1996 for the Company's defined benefit pension plan consists of the following components:
1996 ------------------------------------------------------------------------------------ Service cost-benefits earned during the period $ -- Interest cost on projected benefit obligation 69,647 Actual return on plan assets (19,084) Net amortization and deferral 629 Effect of change in PBGC rate 53,808 ------------------------------------------------------------------------------------ Net periodic pension expense $ 105,000 ====================================================================================
- - -------------------------------------------------------------------------------- Excellence in Community Banking 23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries (7) Retirement Plans and Other Postretirement Benefits (continued) In 1994, the Plan benefits were frozen in anticipation of a complete plan termination. The Company approved termination of the Plan in 1995. The Plan termination was approved by the Internal Revenue Service in 1996 and all Plan benefits were paid to participants. On June 1, 1994, the Company implemented a defined contribution 401(k) plan that covers all eligible employees. The Company matches employee contributions up to certain amounts as defined in the plan. Total expense related to this plan was $98,089, $117,355 and $100,588 in 1998, 1997, and 1996, respectively. The Company also has a postretirement benefit plan whereby the Company pays postretirement health care benefits for certain of its retirees that have met minimum age and service requirements. The following tables provide information relating to the Company's postretirement benefit plan: Postretirement Benefits
- - --------------------------------------------------------------------------------------- 1998 1997 - - --------------------------------------------------------------------------------------- Reconciliation of Benefit Obligation Net benefit obligation, January 1 $ 449,495 464,524 Service Cost 5,662 6,478 Interest cost 31,465 32,517 Actuarial gain (42,601) (39,595) Benefits paid (16,245) (14,429) - - ------------------------------------------------------------------------- ------- Net benefit obligation, December 31 427,776 449,495 ========================================================================= ======= Fair value of plan assets -- -- Funded Status Funded status, December 31 427,776 449,495 Unrecognized actuarial gain 89,032 46,566 - - ------------------------------------------------------------------------- ------- Net amount recognized $ 516,808 496,061 ========================================================================= =======
Net periodic postretirement benefit cost for 1998, 1997 and 1996 includes the following components:
1998 1997 1996 --------------------------------------------------------------------------------- ------- Service cost $ 5,662 $ 6,478 $ 4,832 Interest cost 31,465 32,517 31,966 --------------------------------------------------------------------------------- ------- Net periodic postretirement benefit cost $37,127 $38,995 $36,798 ================================================================================= =======
The following table presents assumptions relating to the plan at December 31, 1998 and 1997:
1998 1997 ----------------------------------------------------------------------------------- ------ Weighted average discount rate in determining benefit obligation 7.0% 7.0% Annual health care cost trend rate 9.0 9.0 Ultimate medical trend rate 8.0 8.0 Medical trend rate period (in years) 5.0 5.0 Effect of 1% increase in assumed health care cost on: Service and interest cost 16.2% 16.4% Benefit obligation 14.6 15.0 Effect of 1% decrease in assumed health care cost on: Service and interest cost (13.3) (14.0) Benefit obligation (12.0) (12.3)
- - -------------------------------------------------------------------------------- 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries (8) Stock Option Plan During 1998, the Company adopted an Omnibus Stock Ownership and Long-Term Incentive Plan ("the Omnibus Plan") which was approved by the Company's shareholders at the May 13, 1998 annual meeting and which provides for the issuance of up to an aggregate of 159,000 shares of common stock of the Company pursuant to stock options and other awards granted or issued under its terms. At that time, the Board of Directors also awarded to certain officers of the Bank options to purchase an aggregate of 9,516 shares of the Company's common stock pursuant to the terms of the Omnibus Plan at a price equal to the then current market value of $12.50 per share. These options expire on May 13, 2008, and are all currently outstanding as of December 31, 1998. Beginning January 2001, one-third of the options become exercisable each year. If the Company had elected to recognize compensation cost for its stock-based compensation plans in accordance with the fair value based accounting method of SFAS No. 123, net income and earnings per share would have been as follows:
1998 ----------------------------------------------------------------------------- Pro Forma As Reported ----------------------------------------------------------------------------- Net income $ 1,951,142 1,959,040 Basic EPS 1.07 1.08 Diluted EPS 1.07 1.08
(9) Related Party Transactions The Company has banking transactions in the ordinary course of business with several of its directors and officers, and their associates. Such transactions are on the same terms as those prevailing at the time for comparable transactions with others. In the opinion of management, loans made to directors, officers and their associates do not involve more than the normal risk of collectibility or present any other unfavorable features (see note 3). (10) Deposits At December 31, 1998 and 1997, certificates of deposit of $100,000 or more amounted to approximately $26,855,000 and $19,503,067, respectively. For the years ended December 31, 1998, 1997 and 1996, interest expense on certificates of deposit of $100,000 or more amounted to approximately $1,254,000, $1,057,000 and $1,038,000, respectively. The Company made interest payments of $5,229,772, $5,249,278 and $4,903,660 during the years ended December 31, 1998, 1997 and 1996, respectively. Time deposit accounts as of December 31, 1998, mature in the following years and amounts: 1999 - $73,603,766; 2000 - $8,338,967; and 2001 - $1,483,718. (11) Stockholders' Equity and Formation of Holding Company On July 22, 1998, and pursuant to a charter amendment, the Bank effected a three-for-one stock split of the Bank's common stock increasing the number of shares of common stock from 593,418 to 1,780,254. Additionally, by way of the same charter amendment, the Bank increased the post-split par value of the common stock from $3.33 per share to $3.50 per share. In connection with the stock split and increase in par value, the Bank increased the capital surplus account in accordance with North Carolina General Statutes Section 53-88. All references to the number of common shares and per share amounts in the financial statements have been restated as appropriate to reflect the effect of the split, for all periods presented. Additionally, common stock, capital surplus, and retained earnings have been restated for all periods presented as appropriate to reflect the stock split, the increase in par value, and the increase in the capital surplus account. - - -------------------------------------------------------------------------------- Excellence in Community Banking 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries On July 22, 1998, the Bank was acquired by Bancorp, which was newly-formed on March 4, 1998, for purposes of such transaction. Each outstanding share of the Bank's common stock was exchanged for one share of Bancorp's common stock with the Bank becoming a wholly-owned subsidiary of Bancorp. Bancorp's primary purpose is to serve as the parent of the Bank. This transaction was accounted for in a manner similar to a pooling-of-interests whereby the historical book values of the Bank's accounts were combined with Bancorp's accounts on the date of the merger. On November 23, 1998 the Company issued 345,000 shares of common stock to the public at a price of $14.25 per share. The net proceeds of the offering were approximately $4,268,000. (12) Leases The Company also has several noncancellable operating leases for three branch locations. These leases generally contain renewal options for periods ranging from three to five years and require the Company to pay all executory costs such as maintenance and insurance. Rental expense for operating leases during 1998 and 1997 was $65,795 and $69,758, respectively. Future minimum lease payments under noncancellable operating leases (with initial or remaining lease terms in excess of one year) as of December 31, 1998 are as follows: Year ending December 31, 1999 $ 65,797 2000 65,797 2001 42,397 2002 9,879 ------------------------------------------------ Total minimum lease payments $183,870 ================================================
(13) Reserve Requirements The aggregate net reserve balances maintained under the requirements of the Federal Reserve, which are noninterest bearing, were approximately $3,157,000 at December 31, 1998. (14) Commitments and Contingencies The Company has various financial instruments (outstanding commitments) with off-balance sheet risk that are issued in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit of $20,411,000 and standby letters of credit of $361,000, at December 31, 1998. The Company's exposure to credit loss for commitments to extend credit and standby letters of credit is the contractual amount of those financial instruments. The Company uses the same credit policies for making commitments and issuing standby letters of credit as it does for on-balance sheet financial instruments. Each customer's creditworthiness is evaluated on an individual case-by-case basis. The amount and type of collateral, if deemed necessary by management, is based upon this evaluation of creditworthiness. Collateral obtained varies, but may include marketable securities, deposits, property, plant and equipment, investment assets, real estate, inventories and accounts receivable. Management does not anticipate any significant losses as a result of these financial instruments and anticipates their funding from normal operations. - - -------------------------------------------------------------------------------- 26 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries (15) Fair Value of Financial Instruments Fair value estimates are made by management at a specific point in time, based on relevant information about the financial instrument and the market. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument nor are potential taxes and other expenses that would be incurred in an actual sale considered. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions and/or the methodology used could significantly affect the estimates disclosed. Similarly, the fair values disclosed could vary significantly from amounts realized in actual transactions. Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. The following table presents the carrying values and estimated fair values of the Company's financial instruments at December 31, 1998 and 1997:
1998 1997 -------------------------------------------------------------------------------------------------------------------------- Carrying Estimated Carrying Estimated value fair value value fair value -------------------------------------------------------------------------------------------------------------------------- Financial assets: Non-interest bearing deposits and cash $ 11,723,000 $ 11,723,000 $ 8,185,000 $ 8,185,000 Federal funds sold -- -- 4,425,000 4,425,000 Investment securities 58,394,000 58,394,000 47,120,000 47,120,000 FHLB common stock 564,800 564,800 503,000 503,000 Net loans 130,274,000 130,770,000 118,549,000 119,094,000 Financial liabilities: Deposits $184,185,000 $175,722,000 $170,909,000 $171,137,000
The estimated fair values of net loans and deposits at December 31 are based on cash flows discounted at market interest rates. The carrying values of other financial instruments, including various receivables and payables, approximate fair value. (16) Regulatory Matters The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The Bank, as a North Carolina chartered bank, may pay dividends only out of undivided profits as determined pursuant to North Carolina General Statutes Section 53-87. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is necessary to ensure the financial soundness of the Bank. - - -------------------------------------------------------------------------------- Excellence in Community Banking 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries (16) Regulatory Matters (continued) Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of December 31, 1998, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 1998, the most recent notification from the Federal Deposit Insurance Corporation ("FDIC") categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category. The Bank's actual capital amounts, in thousands, and ratios are presented in the following table:
To be well capitalized under prompt For capital corrective Actual adequacy purposes action provisions ------------------------------------------------------------------------------------------------------------------------------- Amount Ratio Ratio Ratio ------------------------------------------------------------------------------------------------------------------------------- As of December 31, 1998: Total Capital (to Risk Weighted Assets) $22,957 16.25% >=8.0% >=10.00% Tier I Capital (to Risk Weighted Assets) 21,179 15.00% >=4.0% >=6.00% Tier I Capital (to Average Assets) 21,179 10.45% >=4.0% >=5.00% As of December 31, 1997: Total Capital (to Risk Weighted Assets) $16,973 13.66% >=8.0% >=10.00% Tier I Capital (to Risk Weighted Assets) 15,406 12.40% >=4.0% >=6.00% Tier I Capital (to Average Assets) 15,406 8.53% >=4.0% >=5.00%
In May 1995, the Bank Insurance Fund ("BIF") of the FDIC reached its designated ratio of reserves to insured deposits (i.e., 1.25%). For this reason, the FDIC reduced the assessment rate applicable to BIF deposits in two stages, so that, beginning in 1996, the deposit insurance premiums for 92% of all BIF members in the highest capital and supervisory categories were set at $1,500 per year, regardless of deposit size. Beginning in 1997, BIF members were required to begin paying FICO-bond assessments in addition to the $1,500 annual assessment. The FICO bond assessment was $19,032 for the Company in 1998 and $23,089 in 1997. - - -------------------------------------------------------------------------------- 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries (17) ECB Bancorp, Inc. (Parent Company) ECB Bancorp, Inc.'s principal asset is its investment in the Bank, and its principal source of income is dividends from the Bank. The Parent Company condensed balance sheet as of December 31, 1998, and the related condensed statements of income and cash flows from the period July 22, 1998 (see note 11) to December 31, 1998 are as follows:
CONDENSED BALANCE SHEET Assets Investment in subsidiary $ 21,852,346 ----------------------------------------------------------------------- Total assets $ 21,852,346 ======================================================================= Liabilities and Shareholders' Equity Common stock 7,438,389 Surplus 6,260,392 Retained earnings 7,480,699 Accumulated other comprehensive income 672,866 ------------ Total liabilities and shareholders' equity $ 21,852,346 ======================================================================= CONDENSED STATEMENT OF INCOME Dividends from bank subsidiary $ 453,965 Equity in undistributed net income of subsidiary 603,168 ------------ Net income $ 1,057,133 ======================================================================= CONDENSED STATEMENT OF CASH FLOWS Operating activities: Net income $ 1,057,133 Undistributed net income of subsidiary (603,168) ------------ Net cash provided by operating activities 453,965 ======================================================================= Investing activities: Investment in subsidiary (4,267,892) ------------ Net cash used by investing activities (4,267,892) ======================================================================= Financing activities: Proceeds from issuance of common stock 4,267,892 Cash dividends paid (453,965) ------------ Net cash provided by financing activities 3,813,927 ======================================================================= Net change in cash $ -- =======================================================================
As discussed in note 11, on July 22, 1998 the Parent Company exchanged its common stock for that of the Bank, resulting in an increase in shareholders' equity at the Parent Company of $16,679,425. - - -------------------------------------------------------------------------------- Excellence in Community Banking 29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries - - -------------------------------------------------------------------------------- 30 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries ECB Bancorp, Inc. ("Bancorp") is a bank holding company headquartered in Engelhard, North Carolina, whose wholly-owned subsidiary, The East Carolina Bank (the "Bank") (collectively referred to hereafter as the "Company") is a state chartered community bank which was founded in 1919. The Bank offers a full range of banking services through 15 branches serving eastern North Carolina, including the communities of Engelhard, Swan Quarter, Columbia, Creswell, Fairfield, Nags Head, Manteo, Southern Shores, Barco, Avon, Hatteras, Ocracoke and Greenville (three branches). The Bank also operates a loan production facility in Washington, North Carolina and is expected to open its sixteenth branch in this community in the spring of 1999. The operations of the Company and depository institutions in general are significantly influenced by general economic conditions and by related monetary, fiscal and other policies of depository institution regulatory agencies, including the Federal Reserve Board, the Federal Deposit Insurance Corporation (the "FDIC") and the North Carolina State Banking Commission. The net income of the Bank is dependent, to a large extent, on the differences between interest earned on loans and investments and interest paid on deposits. Deposit flows and costs of funds are influenced by interest rates on competing investments and general market rates of interest. Lending activities are affected by the demand for financing of real estate and other types of loans, which in turn are affected by the interest rates at which such financing may be offered and other factors affecting local demand and availability of funds. Management's discussion and analysis of financial condition and results of operations are presented to assist in understanding the financial condition and results of operations of ECB Bancorp, Inc. and its wholly-owned subsidiary, The East Carolina Bank, for the years of 1998, 1997, and 1996. This discussion and the related financial data should be read in conjunction with the audited consolidated financial statements and related footnotes. Liquidity is the Bank's ability to generate cash to fund asset growth, to meet deposit withdrawals, to maintain regulatory reserve requirements and to pay operating expenses. The principal sources of liquidity are the Bank's investment portfolio, interest from loans and investments, loan principal repayments, and increases in deposits. Sufficient levels of capital are necessary to sustain growth and absorb losses. To this end, the FDIC, which regulates The East Carolina Bank, has established capital adequacy guidelines. These guidelines relate to the Bank's Leverage Capital, and Tier 1 and Total Risk Based Capital ("RBC"). For The East Carolina Bank, Leverage Capital consists of total shareholders' equity excluding unrealized gains or losses, net of income taxes, on securities available-for-sale. As of December 31, 1998, the Bank's Leverage Ratio was 10.45% compared to 8.53% and 8.42%, respectively, at year-end 1997 and 1996. For regulatory purposes, a well-capitalized financial institution must have a Tier 1 Leverage Ratio of at least 5.00%. Within the RBC calculations, The East Carolina Bank's assets, including loan commitments and other off-balance sheet items, are weighted according to Federal regulatory guidelines for risk considered inherent in the assets. The East Carolina Bank's Tier 1 RBC ratio as of December 31, 1998 was 15.00% which is, along with a ratio of 12.40% and 12.49% for 1997 and 1996, respectively, representative of a well-capitalized institution. The calculation of the Total RBC ratio allows, in The East Carolina Bank's circumstances, the inclusion of the allowance for loan losses in capital, but only to the maximum of 1.25% of risk-weighted assets. As of December 31, 1998, the Bank's Total RBC was 16.25% which is representative of a well-capitalized institution. The Total RBC ratios for 1997 and 1996 were 13.66% and 13.75%, respectively, both of which were representative of a well-capitalized financial institution. As of December 31, 1998, shareholders' equity totaled $21.9 million compared to $15.7 million at December 31, 1997. On November 23, 1998 the Company issued 345,000 shares of common stock to the public at a price of $14.25 per share. The net proceeds of the offering were approximately $4,268,000. Shareholders' equity for 1998 and 1997 included $672,866 and $306,780, respectively, of net unrealized securities gains. - - -------------------------------------------------------------------------------- Excellence in Community Banking 31 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries An adequate capital position provides the Company with expansion capabilities. Retention of sufficient earnings to maintain that adequate capital position is an important factor in determining dividends. During 1998, the Company paid $453,965 in dividends, versus $415,393 in 1997 and $379,788 in 1996. As a percentage of net income in 1998, dividends were 23.2% and represented an increase of 9.3% over dividends paid in 1997. In 1998, the Company had net income of $1,959,040, or $1.08 basic and diluted earnings per share, compared to $1,673,251 or $0.94 basic and diluted earnings per share (as restated for three-for-one stock split effected July 22, 1998), for the year ended December 31, 1997. Net interest income after the provision for possible loan losses increased $1,358,599 as a result of an increase in interest income of $1,242,818 and a decrease in interest expense of $4,664. This increase in the Company's net interest margin is attributable to loans representing a larger portion of the Company's total earning assets and, in part, to interest recoveries on certain non-accrual loans and a lower cost of funds. During 1998, the Bank had interest recoveries on non-accrual loans in the amount of $245,700. The provision for possible loan losses decreased $111,117 when compared to 1997 provision expense of $353,513 due primarily to lower levels of nonperforming assets. Management continuously analyzes the growth and risk characteristics of the total loan portfolio under current economic conditions in order to evaluate the adequacy of the allowance for possible loan losses. The factors that influence management's judgement in determining the amount charged to operating expense include past loan loss experience, composition of the loan portfolio, evaluation of probable losses inherent in the portfolio and current economic conditions. The Company's watch committee, which includes three members of senior management as well as regional managers and other credit administration personnel, conducts a quarterly review of all credits classified as substandard. This review follows a re-evaluation by the account officer who has primary responsibility for the relationship. Various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for possible loan losses. Such agencies may require the Company to recognize additions to the allowance for possible loan losses based on their judgments about information available to them at the time of their examination. Nonperforming assets, which consist of loans not accruing interest, restructured debt and real estate acquired in settlement of loans, were $759,000 and $2,325,000 at December 31, 1998 and 1997, respectively. The decrease in nonperforming assets is primarily due to the pay-off of two large nonperforming lending relationships during the year and the sale of a significant portion of real estate acquired in settlement of loans. Through sales, the Company has liquidated all other real estate owned reducing the balance to $50,000 at December 31, 1998 from $490,000 at December 31, 1997. Non-interest income, principally charges for the use of the Company's services, is a significant contributor to net earnings. Non-interest income for 1998 increased $81,000 or 4.2% when compared to 1997. Service charges on deposit accounts increased $31,000 or 6.2%, but were offset by a decrease in Non-Sufficient Funds (NSF) service charges of $87,000, resulting in a $56,000 or 4.0% net decrease when compared to 1997. Other service charges and fees increased $66,000 or 12.6% as a result of increased ATM transaction fees of $55,000 that were effected by the Company after the first quarter of 1997. Other non-interest income increased $71,000 principally due to mortgage loan origination fees of $54,000 generated by the Company's new mortgage loan product. Generally, the Company has been able to increase other income by increasing the prices of its services to partially offset increases in other operating expenses. Non-interest expenses increased by $1,159,000 or 15.4% in 1998 and by 11.2% in 1997. This increase was caused in part by the opening of new full service branches in Avon and Barco, and a loan production office in Washington, North Carolina. A significant component of non-interest expense is salaries and employee benefits. Salary expense increased $247,000 over 1997 partially as a result of opening the aforementioned offices, and employee benefits increased approximately $112,000 as the Company increased cash awards paid to employees participating in the Company's performance based incentive program. When compared to 1997, net occupancy expense increased $97,000 or 15.6% as a result of opening the aforementioned offices and equipment expense increased $107,000 due to the Company upgrading its host processor and continued introduction of branch automation. The Company's telephone expense increased $48,000 over last year as a result of increased usage of the Company's Xpress phone banking system introduced during the second quarter of 1997. Professional fees increased $109,000 in connection with non-recurring legal and accounting fees incurred related to the formation of Bancorp in 1998. - - -------------------------------------------------------------------------------- 32 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries Other non-interest expenses increased $391,000 from $1,420,000 in 1997 to $1,811,000 in 1998. This increase is principally attributable to increases in marketing expense and non-recurring expenses related to the planned closing of the Company's WalMart Supercenter office in March of 1999. Marketing expense increased approximately $182,000 over 1997 as the Company launched a broad range of mortgage products and its new Club 7 Visa Card, a program done in conjunction with a local television station. During December of 1998, the Company expensed approximately $157,000 relating to the closing of the WalMart Supercenter office. These expenses consisted primarily of obligated lease payments of $50,000 and write-off of leasehold improvements of approximately $87,000. In 1997, the Bank had net income of $1,673,251, an increase of $339,488 compared to 1996 net income. Net interest income after the provision for possible loan losses increased $1,045,404 as a result of an increase in interest income of $1,425,690 mitigated by an increase in interest expense of $523,687. The provision for possible loan losses decreased $143,401 when compared to 1996 provision expense of $496,914. Non-interest income, principally charges for the use of the Bank's services, is a significant contributor to net earnings. Non-interest income for 1997 increased $228,000 or 13.3% when compared to 1996. Service charges on deposit accounts for 1997 increased $288,000 as a result of an increased collection rate of NSF fees on transaction accounts. Other service charges and fees increased $106,000 or 25.3% as a result of increased ATM transaction fees of $67,000 and merchant discount income net of merchant processing expense of $39,000. Other non-interest income in 1997 decreased $166,000 due principally to gains realized in 1996 on the sale of real estate acquired in settlement of loans totaling $119,000 and other miscellaneous income totaling $22,000 in 1996. Generally, the Bank has been able to increase other income by increasing the prices of its services to partially offset increases in other operating expenses. Non-interest expenses increased by 11.2% in 1997 and by 10.0% in 1996. A significant component of non-interest expense is salaries and employee benefits. Personnel expense increased $200,000 or 5.4% compared to 1996. This increase was caused in part by the opening of a new branch in Avon and a loan production office in Washington, North Carolina. Net occupancy expense increased $73,000 or 13.3% as a result of opening the aforementioned offices as well as an addition to the Bank's home office. Equipment expense increased $205,000 or 36.4% when compared to 1996. This increase was due in part to opening of new offices but principally to the Bank's 1997 initiative to provide deposit and loan platform automation at its branch locations. During 1997, the Bank installed approximately 50 personal computers and related equipment. In addition, the Bank upgraded its IBM A/S 400 host processor and doubled the number of proof machines used in its item-processing center. Other non-interest expense increased $281,000 principally due to expenses of $80,000 associated with its "BEST" account product offering, increased telephone and data communication cost of approximately $41,000, and stationery and supplies increases of $38,000. - - -------------------------------------------------------------------------------- Excellence in Community Banking 33 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries TABLE 1. AVERAGE BALANCES AND NET INTEREST INCOME ANALYSIS
Year Ended December 31, - - ------------------------------------------------------------------------------------------------------------------------------------ 1998 1997 1996 ---------------------------------------------------------------------------------------------------- Average Yield/ Income/ Average Yield/ Income/ Average Yield/ Income/ Balance Rate Expense Balance Rate Expense Balance Rate Expense - - ------------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) Assets - - --------------------------- Loans - net (1) $124,794 9.63% $ 12,015 $115,487 9.43% $ 10,887 $101,950 9.34% $ 9,522 Taxable securities 31,721 5.91% 1,874 29,705 5.89% 1,750 33,672 5.70% 1,919 Non-taxable securities (2) 15,318 7.44% 1,139 10,254 7.57% 776 9,279 7.71% 715 Federal funds sold 4,601 5.26% 242 9,125 5.38% 491 5,750 5.23% 301 - - --------------------------- -------- ---- -------- -------- ---- -------- -------- ---- -------- Total interest- earning assets 176,434 8.66% $ 15,270 164,571 8.45% 13,904 150,651 8.27% 12,457 Cash and due from banks 9,122 7,715 7,472 Bank premises and equipment, net 6,542 5,929 5,617 Other assets 2,520 2,300 2,229 - - --------------------------- -------- -------- -------- Total assets $194,618 $180,515 $165,969 =========================== ======== ======== ======== Liabilities and Shareholders' equity - - --------------------------- Interest-bearing deposits $140,585 3.81% $ 5,351 $135,789 3.95% $ 5,364 $123,986 3.90% $ 4,831 Borrowed funds 152 5.92% 9 -- -- -- 188 5.32% 10 - - --------------------------- -------- ---- -------- -------- ---- -------- -------- ---- -------- Total interest- bearing liabilities 140,737 3.81% 5,360 135,789 3.95% 5,364 124,174 3.90% 4,841 Non-interest-bearing deposits 35,272 28,574 26,788 Other liabilities 1,314 1,039 1,035 Shareholders' equity 17,295 15,113 13,972 - - --------------------------- -------- -------- -------- Total liabilities and shareholders' equity $194,618 $180,515 $165,969 =========================== ======== ======== ======== Net interest income and net yield on interest-earning assets (FTE) 5.62% $ 9,910 5.19% $ 8,540 5.06% $ 7,616 =========================== ==== ======== ==== ======== ==== ======== Interest rate spread (FTE) 4.85% 4.50% 4.37%
(1) Average loans, net of the allowance for possible loan losses and unearned income. These figures include non-accruing loans, the effect of which is to lower the average rates. (2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis (FTE) using the federal income tax rate of 34%. - - ------------------------------------------------------------------------------- 34 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries Changes in interest income and interest expense can result from variances in both volume and rates. Table 2 below analyzes the effect of variances in volume and rate on taxable-equivalent interest income, interest expense and net interest income. TABLE 2. VOLUME AND RATE VARIANCE ANALYSIS
- - ------------------------------------------------------------------------------------------------------------------------------------ 1998 compared to 1997 1997 compared to 1996 Volume (1) Rate (1) Net Volume (1) Rate (1) Net - - ------------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) Loans $ 887 $ 241 $ 1,128 $ 1,270 $ 95 $ 1,365 Taxable securities 119 5 124 (230) 61 (169) Non-taxable securities (2) 380 (17) 363 75 (14) 61 Federal funds sold (241) (8) (249) 179 11 190 - - -------------------------------------------------------- ------- ------- ------- ------- ------- Interest income 1,145 221 1,366 1,294 153 1,447 Interest-bearing deposits 186 (199) (13) 463 70 533 Borrowed funds 5 4 9 (5) (5) (10) - - -------------------------------------------------------- ------- ------- ------- ------- ------- Interest expense 191 (195) (4) 458 65 523 - - -------------------------------------------------------- ------- ------- ------- ------- ------- Net interest income $ 954 $ 416 $ 1,370 $ 1,835 $ 089 $ 1,924) ======================================================== ======= ======= ======= ======= =======
(1) The combined rate/volume variance for each category has been allocated equally between rate and volume variances. (2) Yields on tax-exempt investments have been adjusted to a taxable-equivalent basis using the federal income tax rate of 34%. - - -------------------------------------------------------------------------------- Excellence in Community Banking 35 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries Rate sensitivity analysis, an important aspect of achieving satisfactory levels of net interest income, is the management of the composition and maturities of rate-sensitive assets and liabilities. The following table sets forth the Company's interest sensitivity analysis at December 31, and describes, at various cumulative maturity intervals, the gap ratios (ratios of rate-sensitive assets to rate-sensitive liabilities) for assets and liabilities that management considers rate sensitive. TABLE 3. RATE SENSITIVITY ANALYSIS AS OF DECEMBER 31, 1998
- - ----------------------------------------------------------------------------------------------------------------------- 3 Months 4 to 12 Total within Over 12 Or Less Months 12 Months Months Total - - ----------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Earning assets Loans - gross $ 56,517 $ 14,745 $ 71,262 $ 61,762 $ 133,024 Investment securities 6,044 8,892 14,936 43,458 58,394 FHLB stock 565 -- 565 -- 565 - - ---------------------------------------------------------------- --------- --------- --------- --------- Total earning assets $ 63,126 $ 23,637 $ 86,763 $ 105,220 $ 191,983 ================================================================ ========= ========= ========= ========= Percent of total earning assets 32.9% 12.3% 45.2% 54.8% 100.0% Cumulative percent of total earning assets 32.9% 45.2% 45.2% 100.0% Interest-bearing liabilities Time deposits of $100,000 or more $ 10,795 $ 13,615 $ 24,410 $ 2,445 $ 26,855 Savings, NOW and Money Market deposits 62,672 -- 62,672 -- 62,672 Other time deposits 21,339 27,912 49,251 7,320 56,571 Federal funds purchased 2,725 -- 2,725 -- 2,725 - - ---------------------------------------------------------------- --------- --------- --------- --------- Total interest-bearing liabilities $ 97,531 $ 41,527 $ 139,058 $ 9,765 $ 148,823 ================================================================ ========= ========= ========= ========= Percent of total interest-bearing liabilities 65.5% 27.9% 93.4% 6.6% 100.0% Cumulative percent of total interest-bearing liabilities 65.5% 93.4% 93.4% 100.0% Ratios Ratio of earning assets to interest-bearing liabilities (gap ratio) 64.7% 56.9% 62.4% 1077.5% Cumulative ratio of earning assets to interest-bearing liabilities (cumulative gap ratio) 64.7% 62.4% 62.4% 129.0% Interest sensitivity gap $ (34,405) $ (17,890) $ (52,295) $ 95,455 $ 43,160 Cumulative interest sensitivity gap $ (34,405) $ (52,295) $ (52,295) $ 43,160 $ 43,160 As a percent of total earning assets (17.9%) (27.2%) (27.2%) 22.5% 22.5%
In periods of rising interest rates, the Company's rate-sensitive assets cannot be repriced as quickly as its rate-sensitive liabilities. Thus, the Company's net interest income generally will decrease during a period of rising interest rates. In periods of declining interest rates the opposite effect occurs. As of December 31, 1998, approximately 45.2% of the Company's interest-earning assets could be repriced within one year and approximately 82.3% of interest-earning assets could be repriced within five years. Approximately 93.4% of interest-bearing liabilities could be repriced within one year and substantially all interest-bearing liabilities could be repriced within five years. - - -------------------------------------------------------------------------------- 36 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries Interest Sensitivity Deregulation of interest rate and short-term, interest bearing deposits which are more volatile, have created a need for shorter maturities of earning assets. As a result, an increasing percentage of commercial, installment and mortgage loans are being made with variable rates or shorter maturities to increase liquidity and interest rate sensitivity. The difference between interest sensitive asset and interest sensitive liability repricing within time periods is referred to as the interest rate sensitivity gap. Gaps are identified as either positive (interest sensitive assets in excess of interest sensitive liabilities) or negative (interest sensitive liabilities in excess of interest sensitive assets). As of December 31, 1998, the Company had a negative one year cumulative gap of 27.2%. The Company has interest earning assets of $87 million maturing or repricing within one year and interest bearing liabilities of $139 million repricing or maturing within one year. This is primarily the result of stable core deposits being used to fund longer term interest earning assets, such as loans and investment securities. A negative gap position implies that interest bearing liabilities (deposits) will reprice at a faster rate than interest earning assets (loans and investments). In a falling rate environment, this position will generally have a positive effect on earnings, while in a rising rate environment this will generally have a negative effect on earnings. The Company's savings and core time deposits of $119 million include interest bearing checking and savings accounts of $63 million. These deposits are considered as repricing in the earliest period because the rate can be changed weekly. However, history has shown that the decreases in the rates paid on these deposits have little, if any, effect on their movement out of the Company. Therefore, in reality, they are not sensitive to changes in market rates and could be considered in the Non-Rate Sensitive column. If this change were made, the Company's rate sensitive liabilities would be more closely matched at the end of the one year period. TABLE 4. MARKET RISK
Principal Maturing in Years ended December 31, - - ---------------------------------------------------------------------------------------------------------------------------- Fair 1999 2000 2001 2002 2003 Thereafter Total Value - - ---------------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Assets Loans Fixed rate $ 13,111 $ 11,927 $ 12,412 $ 9,948 $ 19,470 $ 13,620 $ 80,488 $ 80,984 Average rate (%) 9.18% 9.52% 9.25% 9.01% 8.53% 8.08% 9.02% Variable rate 25,706 4,690 5,147 3,333 4,909 8,751 52,536 52,536 Average rate (%) 9.00% 8.43% 8.69% 8.42% 8.60% 8.59% 8.78% Investment securities Fixed rate 14,910 12,588 6,532 9,322 2,452 11,571 57,375 58,394 Average rate (%) 5.47% 6.14% 6.46% 6.13% 5.93% 6.72% 6.11% Liabilities Savings and interest bearing checking Variable rate 62,672 -- -- -- -- -- 62,672 60,458 Average rate (%) 1.45% -- -- -- -- -- 1.77% Certificates of deposits Fixed rate 73,327 8,337 1,484 -- -- -- 83,148 83,248 Average rate (%) 4.96% 5.47% 5.18% -- -- -- 5.35% Variable rate 276 2 -- -- -- -- 278 278 Average rate (%) 2.96% 3.34% -- -- -- -- 3.34% Federal funds purchased Variable rate 2,725 -- -- -- -- -- 2,725 2,725 Average rate (%) 5.92% -- -- -- -- -- 5.92%
- - -------------------------------------------------------------------------------- Excellence in Community Banking 37 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries Non-interest income, principally charges for the use of the Company's services, is a significant contributor to net earnings. Non-interest income for 1998 increased $81,000 or 4.2% when compared to 1997. Service charges on deposit accounts increased $31,000 or 6.2% but was offset by a decrease in NSF service charges of $87,000, resulting in a $56,000 or 4.0% net decrease when compared to the same period in 1997. Other service charges and fees increased $66,000 as a result of increased ATM surcharge fees of $55,000 that were effected by the Company after the first quarter of 1997. Other operating income increased $71,000 principally due to mortgage loan origination fees of $54,000 generated by the Company's new mortgage loan product. TABLE 5. NON-INTEREST INCOME
Year ended December 31, ================================================ ====== ====== 1998 1997 1996 - - ------------------------------------------------ ------ ------ (dollars in thousands) Service charges on deposit accounts $1,335 $1,391 $1,103 Other service charges and fees 591 525 419 Other 101 30 196 - - ------------------------------------------------ ------ ------ Total $2,027 $1,946 $1,718 ================================================ ====== ======
Non-interest expenses increased by $1,159,000 or 15.4% in 1998. This increase is principally due to the opening of a new full service branch in Avon and Barco, and a loan production office in Washington, North Carolina. Salaries and related personnel expenses increased $360,000 over 1997 due principally to the opening of these offices. When compared to 1997, net occupancy expense increased $97,000 or 15.6% as a result of opening the aforementioned offices and equipment increased $107,000 due to the Company upgrading its host computer system and the introduction of branch automation. The Company's telephone expense increased $48,000 over last year as a result of increased usage of the Company's Xpress phone banking system introduced during the second quarter of 1997. Professional fees increased approximately $109,000 in connection with non-recurring legal and accounting fees incurred related to the formation of a holding company. Other operating expenses increased $391,000 from $1,420,000 in 1997 to $1,811,000 in 1998. This increase is primarily attributable to increases in marketing expenses and non-recurring expense related to the planned closing of the Company's WalMart Supercenter office in March of 1999. Marketing expense increased approximately $182,000 over 1997 as the Company launched a broad range of mortgage products and its new Club 7 Visa Card, a program done in conjunction with a local television station. During December of 1998, the Company expensed approximately $157,000 relating to the closing of the WalMart Supercenter office. These expenses consisted primarily of obligated lease payments of $50,000 and write-off of leasehold improvements of approximately $87,000. TABLE 6. NON-INTEREST EXPENSES
Year ended December 31, - - ---------------------------------------------------------- ------ ------ 1998 1997 1996 - - ---------------------------------------------------------- ------ ------ (dollars in thousands) Salaries $3,186 $2,939 $2,770 Retirement and other employee benefits 1,084 971 940 Occupancy 720 623 550 Equipment 875 768 563 Deposit insurance premiums 21 25 2 Professional fees 318 209 198 Supplies 251 222 184 Telephone 265 217 176 Postage 172 150 143 Other 1,811 1,420 1,259 - - ---------------------------------------------------------- ------ ------ Total $8,703 $7,544 $6,785 ========================================================== ====== ======
- - -------------------------------------------------------------------------------- 38 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries ANALYSIS OF FINANCIAL CONDITION Management believes the Company's financial condition is sound. The following discussion focuses on the factors considered by management to be important in assessing the Company's financial condition. The following table sets forth the percentage of significant components of the Company's balance sheets at December 31, 1998 and 1997. TABLE 7. DISTRIBUTION OF ASSETS AND LIABILITIES
December 31, - - --------------------------------------------------------------------------------------------------------- 1998 1997 - - --------------------------------------------------------------------------------------------------------- (dollars in thousands) Assets Loans (net) $130,274 61.9% $118,549 63.0% Investment securities 58,394 27.7% 47,120 25.0% FHLB stock 565 0.3% 503 0.3% Federal funds sold -- --% 4,425 2.4% - - ------------------------------------------------------------------- ------ -------- ----- Total earning assets 189,233 89.9% 170,597 90.7% Cash and due from banks 11,787 5.6% 8,281 4.4% Bank premises and equipment, net 7,007 3.3% 6,266 3.3% Other assets 2,457 1.2% 3,084 1.6% - - ------------------------------------------------------------------- ------ -------- ----- Total assets $210,484 100.0% $188,228 100.0% Liabilities and shareholders' equity Demand deposits $ 38,086 18.1% $ 31,897 16.9% Savings, NOW and Money Market deposits 62,672 29.8% 55,969 29.7% Time deposits of $100,000 or more 26,855 12.8% 19,503 10.4% Other time deposits 56,572 26.9% 63,540 33.8% - - ------------------------------------------------------------------- ------ -------- ----- Total deposits 184,185 87.5% 170,909 90.8% Federal funds purchased 2,725 1.3% -- -- Accrued expense and other liabilities 1,722 0.8% 1,606 0.9% - - ------------------------------------------------------------------- ------ -------- ----- Total liabilities 188,632 89.6% 172,515 91.7% Shareholders' equity 21,852 10.4% 15,713 8.3% - - ------------------------------------------------------------------- ------ -------- ----- Total liabilities and shareholders' equity $210,484 100.0% $188,228 100.0% =================================================================== ====== ======== ======
[THE FOLLOWING TABLE WAS REPRESENTED AS A BAR CHART IN THE PRINTED MATERIALS.]
Total Assets (In Thousands) 1994 $153,553 1995 $165,408 1996 $167,218 1997 $188,228 1998 $210,484
[THE FOLLOWING TABLE WAS REPRESENTED AS A BAR CHART IN THE PRINTED MATERIALS.]
Total Deposits (In Thousands) 1994 $141,044 1995 $150,436 1996 $151,336 1997 $170,909 1998 $184,185
- - -------------------------------------------------------------------------------- Excellence in Community Banking 39 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries INVESTMENT PORTFOLIO The carrying values of investment securities held by the Company at the dates indicated are summarized as follows: TABLE 8. INVESTMENT PORTFOLIO COMPOSITION
December 31, - - ------------------------------------------------------------------------------------------------------------ 1998 1997 - - ------------------------------------------------------------------------------------------------------------ (dollars in thousands) Securities available-for-sale U.S. Treasury $19,452 33.3% $25,228 53.6% U.S. Government agencies 20,962 35.9% 7,052 14.9% Mortgage-backed securities 555 1.0% 783 1.7% State and political subdivisions 17,425 29.8% 14,057 29.8% - - ------------------------------------ ------- ----- ------- ----- Total investments $58,394 100.0% $47,120 100.0% - - ------------------------------------ ------- ----- ------- -----
The following table shows maturities of the carrying values of investment securities held by the Company at December 31, 1998, and the weighted average yields. TABLE 9. INVESTMENT PORTFOLIO MATURITY SCHEDULES
After One Year After Five Years Within But Within But Within After One Year Five Years Ten Years Ten Years - - ------------------------------------------------------------------------------------------------------------------------------- Amount Yield Amount Yield Amount Yield Amount Yield Total Yield - - ------------------------------------------------------------------------------------------------------------------------------- Available-for-Sale: U.S. Treasury $ 6,022 5.95% $13,430 6.18% -- -- -- -- $19,452 6.11% U.S. Government agencies 7,671 4.97% 13,291 5.73% -- -- -- -- 20,962 5.48% Mortgage-backed securities -- -- -- -- -- -- $ 555 6.47% 555 6.47% State and political subdivisions (1) 1,249 6.63% 4,742 7.54% 5,396 6.82% 6,038 6.67% 17,425 6.95% - - ------------------------ ------- ---- ------- ---- ------- ---- ------- ---- ------- ---- Total $14,942 5.50% $31,463 6.20% $ 5,396 6.82% $ 6,593 6.66% $58,394 6.13% ======================== ======= ==== ======= ==== ======= ==== ======= ==== ======= ====
(1) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis using the federal income tax rate of 34%. The weighted average yields shown are calculated on the basis of cost and effective yields for the scheduled maturity of each security. At December 31, 1998 the market value of the investment portfolio was approximately $1,019,000 above its book value, which is the result of lower market interest rates compared to the interest rates on the investments in the portfolio. - - -------------------------------------------------------------------------------- 40 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries LOAN PORTFOLIO The Company's management believes the loan portfolio is adequately diversified and contains no foreign loans. Real estate loans represent approximately 49% of the Company's loan portfolio. Real estate loans are primarily loans secured by real estate, mortgage, and construction loans. The Company does not have a large portfolio of home mortgage loans. See note (1) below. Commercial loans are spread throughout a variety of industries, with no particular industry or group of related industries accounting for a significant portion of the commercial loan portfolio. At December 31, 1998, the ten largest loans of the Company accounted for approximately 7% of the Company's outstanding loans. As of December 31, 1998, the Company had outstanding loan commitments of approximately $20,411,000. The amounts of loans outstanding and the percentage that such loans represented of total loans at the indicated dates are shown in the following table according to loan type. TABLE 10. LOAN PORTFOLIO COMPOSITION
December 31, - - ------------------------------------------------------------------------------------------------ 1998 1997 - - ------------------------------------------------------------------------------------------------ (dollars in thousands) Real estate (1) $ 64,538 48.5% $ 63,300 52.2% Installment loans 11,339 8.5% 25,424 21.0% Credit cards and related plans 3,694 2.8% 3,415 2.8% Commercial and all other loans 53,453 40.2% 29,070 24.0% - - ------------------------------------------------------- ----- -------- ----- Total $133,024 100.0% $121,209 100.0% ======================================================= ===== ======== =====
(1) The majority of these loans are various consumer and commercial loans with approval based on cash flow and not the real estate. The majority of the commercial real estate is owner-occupied and operated. MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES The following table sets forth the maturity distribution of the Company's loans as of December 31, 1998. A significant majority of loans maturing after one year are repriced at two and three year intervals. In addition, approximately 39% of the Company's loan portfolio is comprised of variable rate loans. TABLE 11. LOAN MATURITIES
- - ------------------------------------------------------------------------------------------------------------------------------------ Credit cards Commercial Real and related and all estate Installment plans other loans Total - - ------------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) Due in 1 year or less $ 8,678 $ 1,349 $ 3,694 $ 25,096 $ 38,817 Due after 1 year through 5 years: Floating interest rates 10,826 294 -- 6,959 18,079 Fixed interest rates 33,153 8,974 -- 11,630 53,757 Due after 5 years: Floating interest rates 2,933 23 -- 5,795 8,751 Fixed interest rates 8,948 699 -- 3,973 13,620 - - -------------------------------------------------------- -------- -------- -------- -------- -------- Total $ 64,538 $ 11,339 $ 3,694 $ 53,453 $133,024 ======================================================== ======== ======== ======== ======== ========
- - -------------------------------------------------------------------------------- Excellence in Community Banking 41 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries NONPERFORMING ASSETS AND PAST DUE LOANS A loan is placed on non-accrual status when, in management's judgment, the collection of interest income appears doubtful or the loan is past due 90 days or more. Interest receivable that has been accrued and is subsequently determined to have doubtful collectibility is charged to the appropriate interest income account. Interest on loans that are classified as non-accrual is recognized when received. In some cases, where borrowers are experiencing financial difficulties, loans may be restructured to provide terms significantly different from the original terms. Foreclosed properties are included in other assets and represent other real estate that has been acquired through loan foreclosures or deeds in lieu of foreclosure. Such properties are initially recorded at the lower of cost or fair value less estimated costs to sell. Thereafter the properties are maintained at the lower of cost or fair value less estimated costs to sell. The following table summarizes the Company's nonperforming assets and past due loans at the dates indicated. TABLE 12. NONPERFORMING ASSETS AND PAST DUE LOANS
December 31, - - ---------------------------------------------------------- 1998 1997 - - ---------------------------------------------------------- (dollars in thousands) Non-accrual loans $ 88 $1,463 Restructured loans 621 522 Foreclosed properties 50 340 - - ------------------------------------------- ------ Total $ 759 $2,325 =========================================== ======
As December 31, 1998 and 1997, nonperforming assets and past due loans were approximately 0.57% and 1.92%, respectively, of the loans outstanding at such dates. SUMMARY OF LOAN LOSS EXPERIENCE The allowance for possible loan losses is created by direct charges to operations. Losses on loans are charged against the allowance in the period in which such loans, in management's opinion, become uncollectible. Recoveries during the period are credited to this allowance. The factors that influence management's judgment in determining the amount charged to operating expense include past loan loss experience, composition of the loan portfolio, evaluation of estimated probable loan losses and current economic conditions. The Company's loan watch committee, which includes three members of senior management as well as regional managers and other credit administration personnel, conducts a quarterly review of all credits classified as substandard. This review follows a re-evaluation by the account officer who has primary responsibility for the relationship. The following table sets forth the allowance for possible loan losses at December 31, 1998 and 1997. TABLE 13. ALLOCATION OF ALLOWANCE FOR POSSIBLE LOAN LOSSES
December 31, - - -------------------------------------------------------------------------------------------------------------- 1998 1997 - - -------------------------------------------------------------------------------------------------------------- Percent of Percent of Total Loans in Total Loans in Amount Each Category Amount Each Category - - -------------------------------------------------------------------------------------------------------------- (dollars in thousands) Real estate $1,619 48.5% $1,690 52.2% Installment loans 166 8.5% 389 21.0% Credit cards and related plans 160 2.8% 390 2.8% Commercial and all other loans 624 40.2% 149 24.0% - - --------------------------------------------------------- ----- ------ ----- Total allocated 2,569 100.0% 2,618 100.0% Unallocated 181 42 - - --------------------------------------------------------- ------ Total $2,750 $2,660 ========================================================= ======
- - -------------------------------------------------------------------------------- 42 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries Management considers the allowance for possible loan losses adequate to cover estimated probable loan losses on the loans outstanding as of each reporting period. It must be emphasized, however, that the determination of the allowance using the Company's procedures and methods rests upon various judgments and assumptions about economic conditions and other factors affecting loans. No assurance can be given that the Company will not in any particular period sustain loan losses that are sizable in relation to the amount reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for possible loan losses or future charges to earnings. For 1998, 1997, and 1996, the following table summarizes the Company's balances of loans outstanding, average loans outstanding, changes in the allowance arising from charge-offs and recoveries by category, and additions to the allowance that have been charged to expense. TABLE 14. LOAN LOSS AND RECOVERY EXPERIENCE
Year ended December 31, - - ------------------------------------------------------------------------------------------------------------------------------------ 1998 1997 1996 - - ------------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands) Total loans outstanding at end of year $133,024 $121,209 $112,656 ================================================================================================= ======== ======== Average loans outstanding 127,650 118,185 104,297 ================================================================================================= ======== ======== Allowance for possible loan losses at beginning of year $ 2,660 $ 2,400 $ 1,950 Loans charged off: Real estate 21 6 12 Installment loans 89 62 62 Credit cards and related plans 119 110 111 Commercial and all other loans 2 17 81 - - ------------------------------------------------------------------------------------------------- -------- -------- Total charge-offs 231 195 266 Recoveries of loans previously charged off: Real estate -- -- 118 Installment loans 22 22 26 Credit cards and related plans 23 36 34 Commercial and all other loans 34 43 41 - - ------------------------------------------------------------------------------------------------- -------- -------- Total recoveries 79 101 219 Net charge-offs 152 94 47 Additions to the allowance charged to expense 242 354 497 - - ------------------------------------------------------------------------------------------------- -------- -------- Allowance for possible loan losses at end of year $ 2,750 $ 2,660 $ 2,400 ================================================================================================= ======== ======== Ratios Net charge-offs during year to average loans outstanding during year 0.12% 0.08% 0.05% Net charge-offs during year to loans at year-end 0.11% 0.08% 0.04% Allowance for possible loan losses to average loans 2.15% 2.25% 2.30% Allowance for possible loan losses to loans at year-end 2.07% 2.19% 2.13% Net charge-offs to allowance for possible loan losses 5.53% 3.53% 1.96% Net charge-offs to provision for possible loan losses 62.81% 26.55% 9.46%
- - -------------------------------------------------------------------------------- Excellence in Community Banking 43 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries DEPOSITS The average amounts of deposits of the Company for the years ended December 31, 1998, and 1997 are summarized below. TABLE 15. AVERAGE DEPOSITS Year ended December 31,
- - ----------------------------------------------------------------------------------------------------- 1998 1997 - - ----------------------------------------------------------------------------------------------------- Average Average Balance Rate Balance Rate - - ----------------------------------------------------------------------------------------------------- (dollars in thousands) Interest-bearing demand deposits $ 42,807 1.60% $ 40,029 1.75% Savings deposits 14,648 1.94% 14,956 2.06% Time deposits 83,130 5.27% 80,804 5.39% - - ---------------------------------------------------------- ----- -------- ----- Total interest-bearing deposits 140,585 3.81% 135,789 3.95% - - ---------------------------------------------------------- ----- -------- ----- Non-interest-bearing deposits 35,272 -- 28,574 -- - - ---------------------------------------------------------- ----- -------- ----- Total deposits $175,857 3.04% $164,363 3.26% ========================================================== ===== ======== =====
The Company has a large, stable base of time deposits with little dependence on volatile deposits of $100,000 or more. The time deposits are principally certificates of deposits and individual retirement accounts obtained from individual customers. Deposits of certain local governments and municipal entities represented approximately 9.7% of the Company's total deposits at December 31, 1998. All such public funds are collateralized by investment securities. The Company does not purchase brokered deposits. As of December 31, 1998, the Company held approximately $26,855,000 in time deposits of $100,000 or more and time deposits less than $100,000 of $56,571,000. The following table is a maturity schedule of time deposits as of December 31, 1998. TABLE 16. TIME DEPOSIT MATURITY SCHEDULE
- - ---------------------------------------------------------------------------------------------------------------------- 3 Months 4 to 6 7 to 12 Over 12 Or Less Months Months Months Total - - ---------------------------------------------------------------------------------------------------------------------- (dollars in thousands) Time certificates of deposit of $100,000 or more $10,795 $5,925 $7,690 2,445 $26,855 Time certificates of deposit less than $100,000 21,339 14,635 13,277 7,320 56,571 - - ------------------------------------------------------------- ------- ------- ------ ------- Total time deposits $32,134 $20,560 $20,967 $9,765 $83,426 ============================================================= ======= ======= ====== =======
RETURN ON ASSETS AND EQUITY The following table shows return on assets (net income divided by average assets), return on equity (net income divided by average shareholders' equity), dividend payout ratio (dividends declared per share divided by net income per share) and shareholders' equity to assets ratio (average shareholders' equity divided by average total assets) for each of the years presented. TABLE 17. RETURN ON ASSETS AND EQUITY
Year ended December 31, - - ---------------------------------------------------------------------- 1998 1997 1996 - - ---------------------------------------------------------------------- Return on assets 1.01% 0.93% 0.80% Return on equity 11.33% 11.07% 9.55% Dividend payout 23.64% 24.82% 28.44% Shareholders' equity to assets 8.89% 8.37% 8.42%
- - -------------------------------------------------------------------------------- 44 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries ACCOUNTING AND OTHER MATTERS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Earlier application of all of the provisions of this statement is encouraged. The Company plans to adopt this statement at January 1, 2000 and does not anticipate any material effect on its consolidated financial statements. In October 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise". This statement allows mortgage banking firms to account for certain securities and other interests retained after securitizing mortgage loans that were held for sale based on the ability and intent to hold or sell such investments, consistent with the guidance contained in SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities". This statement is effective for the first fiscal quarter beginning after December 15, 1998. The Company plans to adopt this statement on January 1, 1999 and does not anticipate any material effect on its consolidated financial statements. The FASB also issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to issued exposure drafts and to proposed effective dates. Year 2000 Issue GENERAL. The year 2000 ("Y2K") issue confronting the Company and its suppliers, customers, customers' suppliers and competitors centers on the potential inability of certain computer systems to recognize the year 2000. Many existing computer programs and systems originally were programmed with six digit dates that provided only two digits to identify the calendar year in the date field. With the impending new millennium, these programs and computers will recognize "00" as the year 1900 rather than the year 2000. Financial institution regulators recently have increased their focus upon Y2K compliance issues and have issued guidance concerning the responsibilities of senior management and directors. The Federal Financial Institutions Examination Council ("FFIEC") has issued several interagency statements on Y2K Project Management Awareness. These statements require financial institutions to, among other things, examine the Y2K implications of their reliance on vendors and with respect to data exchange and the potential impact of the Y2K issue on their customers, suppliers and borrowers. These statements also require each federally regulated financial institution to survey its exposure, measure its risk and prepare a plan to address the Y2K issue. In addition, the federal banking regulators have issued safety and soundness guidelines to be followed by insured depository institutions, such as the Bank, to assure resolution of any Y2K problems. The federal banking agencies have asserted that Y2K testing and certification is a key safety and soundness issue in conjunction with regulatory exams and, thus, that an institution's failure to address appropriately the Y2K issue could result in supervisory action, including the reduction of the institution's supervisory ratings, the denial of applications for approval of mergers or acquisitions or the imposition of civil money penalties. RISKS. Like most financial service providers, the Company and its operations may be significantly affected by the Y2K issue due to its dependence on technology and date-sensitive data. Computer software and hardware and other equipment, both within and outside the Company's direct control, and third parties with whom the Company electronically or operationally interfaces (including without limitation its customers and third party vendors) may be affected. If computer systems are not modified in order to be able to identify the year 2000, many computer applications could fail or create erroneous results. As a result, many calculations which rely on date field information, such as interest, payment or due dates and other operating functions, could generate results which are significantly misstated, and the Company would experience an inability to process transactions, prepare statements or engage in similar normal business activities. Likewise, under certain circumstances, a failure to adequately address the Y2K issue could adversely affect the viability of the Company's suppliers and creditors and the creditworthiness of its borrowers. Thus, if not - - -------------------------------------------------------------------------------- Excellence in Community Banking 45 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries adequately addressed, the Y2K issue could result in a significant adverse impact on the Company's operations and, in turn, its financial condition and results of operations. STATE OF READINESS. During November 1997, the Company formulated its plan to address the Y2K issue. Since that time, the Company has taken the following steps: Established senior management advisory and review responsibilities; Completed a company-wide inventory of applications and system software; Built an internal tracking database for application and vendor software; Developed compliance plans and schedules for all lines of business; Begun computer code testing; Initiated vendor compliance verification; Begun awareness and education activities for employees through existing internal communication channels; and Developed a process to respond to customer inquiries as well as help educate customers on the Y2K issue. The following paragraphs summarize the phases of the Company's Y2K plan: AWARENESS PHASE. The Company formally established a Y2K plan headed by a senior manager, and a project team was assembled for management of the Y2K project. The project team created a plan of action that includes milestones, budget estimates, strategies, and methodologies to track and report the status of the project. Members of the project team also attended conferences and information sharing sessions to gain more insight into the Y2K issue and potential strategies for addressing it. This phase is substantially complete. ASSESSMENT PHASE. The Company's strategies were further developed with respect to how the objectives of the Y2K plan would be achieved, and a Y2K business risk assessment was made to quantify the extent of the Company's Y2K exposure. A corporate inventory (which is periodically updated as new technology is acquired and as systems progress through subsequent phases) was developed to identify and monitor Y2K readiness for information systems (hardware, software, utilities, and vendors) as well as environmental systems (security systems, facilities, etc.). Systems were prioritized based on business impact and available alternatives. Mission critical systems supplied by vendors were researched to determine Y2K readiness. If Y2K-ready versions were not available, the Company began identifying functional replacements which were either upgradable or currently Y2K-ready, and a formal plan was developed to repair, upgrade or replace all mission critical systems. This phase is substantially complete. In August 1997, the Company began Y2K discussions with its larger borrowers at the time of the annual review of their loans. Beginning in January 1998, all credits greater than $250,000 were evaluated for Y2K exposure by the relationship account officer using a questionnaire developed by the Company's credit administration staff. As part of the current credit approval process, all new and renewed loans are evaluated for Y2K risk. During the course of these evaluations, Company personnel have met individually with each of its larger borrowers to discuss and obtain information regarding each borrower's dependence on information technology and third party vendors and the nature of steps being taken by the borrowers to address their Y2K risk. While the Company will continue to monitor the progress being made by its larger borrowers in addressing their own Y2K issues, to date the Company is generally satisfied with these customers' responses to the Company's inquiries and their progress in addressing their Y2K risk. RENOVATION PHASE. The Company's corporate inventory revealed that Y2K upgrades were available for all vendor supplied mission critical systems, and all these Y2K-ready versions have been delivered and placed into production and have entered the validation process. VALIDATION PHASE. The validation phase is designed to test the ability of hardware and software to accurately process date sensitive data. The Company currently is in the process of validation testing of each mission critical system, with the degree of completion of such testing ranging from 25% to 100%. The Company has created a test environment comprised of an IBM Model 170 dedicated to Y2K testing which is virtually insulated from production and development environments. The Company anticipates that the validation phase will absorb approximately 50% of the total Y2K resources (computer and personnel) over the life cycle of the project. The Company has increased staff in anticipation of that work effort. The Company's validation phase is subs- - - -------------------------------------------------------------------------------- 46 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - --------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries tantially complete for all mission critical systems (with the exception of the Company's automated teller machine network as to which validation testing will be completed during the first quarter of 1999). During the validation testing process to date, no significant Y2K problems have been identified relating to any modified or upgraded mission critical systems. IMPLEMENTATION PHASE. The Company's plan calls for putting Y2K-ready code into production before having actually completed Y2K validation testing. Y2K-ready modified or upgraded versions have been installed and placed into production with respect to all mission critical systems. COMPANY RESOURCES INVESTED. The Company's Y2K project team has been assigned the task of ensuring that all systems across the Company are identified, analyzed for Y2K compliance, corrected if necessary, tested, and changes put into service. The Y2K project team members represent all functional areas of the Company, including branches, data processing, loan administration, accounting, item processing and operations, compliance, internal audit, human resources, and marketing. The team is headed by a vice president who reports directly to a member of the Company's senior management team. The Company's Board of Directors oversees the Y2K plan and provides guidance and resources to, and receives quarterly updates from, the Y2K project team. The Company is expensing all costs associated with required system changes as those costs are incurred, and such costs are being funded through operating cash flows. The total cost of the Y2K conversion project for the Company is estimated to be $200,000. Expenses of approximately $47,000 were incurred and expensed by the Company in 1998 and the Company life-to-date has expensed approximately $54,000. The Company does not expect significant increases in future data processing costs relating to Y2K compliance. CONTINGENCY PLANS. During the assessment phase, the Company began to develop back-up or contingency plans for each of its mission critical systems. The Company's contingency plans are based upon its most reasonably likely worst-case scenario of failure or interruptions of service from electrical and telephone providers. Virtually all of the Company's mission critical systems are dependent upon third party vendors or service providers, therefore, contingency plans include selecting a new vendor or service provider and converting to their system. In the event a current vendor's system fails during the validation phase and it is determined that the vendor is unable or unwilling to correct the failure, the Company will convert to a new system from a pre-selected list of prospective vendors. In each case, realistic trigger dates have been established to allow for orderly and successful conversions. For some systems, contingency plans consist of using spreadsheets software or reverting to manual systems until system problems can be corrected. The majority of the Company's mission critical systems fall into the categories of its core-banking software, its proof of deposit system, and its automated teller machine network. The Company has received warranties from vendors to the effect that the proof of deposit and automated teller machine network software is Y2K-ready. While no warranty has been received with respect to the core-banking system, that system is used by a number of banking institutions and has been reviewed by the Federal Reserve Bank of Atlanta for year 2000 readiness. With respect to each third party with whom the Company interfaces electronically or from whom it obtains services or supplies (such as the Company's credit and debit card processors, its correspondent bank, the Federal Reserve Bank of Richmond, its electric and telephone companies, and its suppliers of business forms), the Company has requested information regarding that party's preparations and state of preparedness with respect to Y2K issues. While, in general, no such third parties will give warranties or guarantees with respect to Y2K issues, the Company has received from each third party in writing an acknowledgment of that party's awareness of the Y2K issues, information regarding its plan for addressing Y2K concerns, and an assurance that steps are being taken to prevent service interruptions. While these assurances do not give the Company any specific legal rights or remedies, the Company generally is satisfied with the responses it has received. In the case of third parties with whom the Company interfaces electronically, testing of those interfaces is being conducted or is scheduled and interruptions in the services provided by such third parties have been taken into account in the Company's contingency plans (which, for example, provide for increased inventories of business forms and supplies, increased levels of cash on hand, use of a generator to operate the Company's main computer system and operations function, manual processing of branch transactions, direct clearing of checks through the Federal Reserve rather than through a correspondent bank, and, where possible, a change to a different third party supplier). Management is not aware of any known trends, events, uncertainties, or current recommendations by regulatory authorities that will or that are reasonably likely to have a material effect on the Company's liquidity, capital resources or other operations. - - -------------------------------------------------------------------------------- Excellence in Community Banking 47 BOARD OF DIRECTORS AND SUBSIDIARY CORPORATIONS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries Board of Directors George Thomas Davis, Jr. Vice Chairman of the Board Attorney at Law Davis & Davis Attorneys Swan Quarter, North Carolina C. Gilbert Gibbs Farmer and Merchant C.G. Gibbs Hardware Engelhard, North Carolina Gregory C. Gibbs Student NC State University Raleigh, North Carolina John F. Hughes, Jr. Region Manager North Carolina Power Manteo, North Carolina Arthur H. Keeney, III President and CEO The East Carolina Bank Engelhard, North Carolina J. Bryant Kittrell, III President and Owner Kittrell & Associates, Inc. Greenville, North Carolina Joseph T. Lamb, Jr. President Joe Lamb, Jr. & Associates, Inc. Real Estate Sales Nags Head, North Carolina B. Martelle Marshall Restaurant Owner Martelle's Bar-B-Q Engelhard, North Carolina Robert L. Mitchell Barber and Retired Magistrate Mitchell's Barber Shop Columbia, North Carolina R.S. Spencer, Jr. Chairman of the Board President, R.S. Spencer, Inc. Merchant Engelhard, North Carolina Ray Mitchell Spencer Retired Farmer Swan Quarter, North Carolina Jo Ellen G. Cutrell Corporate Secretary The East Carolina Bank Subsidiary Corporations - - -------------------------------------------------------------------------------- CAROLINA FINANCIAL REALTY, INC. - - ------------------------------- Gregory C. Gibbs President B. Martelle Marshall Vice President Arthur H. Keeney, III Corporate Secretary and Treasurer CAROLINA FINANCIAL COURIER, INC. - - -------------------------------- Gregory C. Gibbs President B. Martelle Marshall Vice President Arthur H. Keeney, III Corporate Secretary and Treasurer - - -------------------------------------------------------------------------------- 48 BANK SENIOR MANAGEMENT and CORPORATE OFFICERS - - -------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries Bank Senior Management * Arthur H. Keeney, III President and Chief Executive Officer * J. Dorson White, Jr. Executive Vice President Branch Administration * Gary M. Adams Senior Vice President Chief Financial Officer * William F. Plyler, II Senior Vice President Chief Credit Officer * Sarah M. Stephens Senior Vice President Human Resources Jo Ellen G. Cutrell Corporate Secretary * Denotes Policy-making Officers of the Bank - - -------------------------------------------------------------------------------- Corporate Officers Arthur H. Keeney, III President and Chief Executive Officer Gary M. Adams Senior Vice President Chief Financial Officer Jo Ellen G. Cutrell Corporate Secretary - - -------------------------------------------------------------------------------- Excellence in Community Banking 49 BANK OFFICERS AND DEPARTMENT MANAGERS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries Bank Officers Accounting Judith C. Tomlinson Vice President Agri-Business Arthur R. "Buck" Spruill, III Vice President Agri-Business Officer Jeffrey B. Williamson Assistant Vice President Agri-Business Officer Walter T. "Tom" Felton Banking Officer Agri-Business Officer Audit/COMPLIANCE Thomas B. Heggie, III Vice President Vincent L. Midgette Banking Officer BANK CARD SERVICES T. Ann Williams Vice President BANK OPERATIONS Edna H. Sukeforth Vice President CREDIT ADMINISTRATION Marla C. Gibbs Vice President Matthew J. Byrne Vice President MANAGEMENT INFORMATION SYSTEMS Edward H. Heflin Vice President MARKETING Mimi W. Van Nortwick Assistant Vice President Elizabeth C. Stanley Assistant Vice President - - -------------------------------------------------------------------------------- Bank Department Managers CENTRAL PURCHASING Denise L. Gibbs DATA ENTRY Jean M. Raczenski-Clarke DATA PROCESSING C. Todd Mason FACILITIES MAINTENANCE Jerry W. Gibbs ITEM PROCESSING Devonda Howard TECHNICAL SUPPORT Candis L. Castellow - - -------------------------------------------------------------------------------- 50 BRANCH OFFICERS - - -------------------------------------------------------------------------[LOGO] The East Carolina Bank and Subsidiaries Bank Senior Management CENTRAL REGION COLUMBIA David W. Noell Branch Manager Dawn L. Harrell Branch Operations Manager CRESWELL Betty B. Cabarrus Vice President Branch Manager Eloise F. Hassell Branch Operations Manager ENGELHARD Beverly B. Meekins Branch Manager Lori G. Cahoon Branch Operations Manager FAIRFIELD Faye C. Sadler Vice President Branch Manager SWAN QUARTER Faye C. Sadler Vice President Branch Manager WASHINGTON John E. Wojcik Vice President Branch Manager* - - -------------------------------------------------------------------------------- EASTERN REGION T. Olin Davis Vice President Eastern Region Manager Richard N. "Skipper" Hines, III Vice President Business Development Officer AVON Roberta L. Midgett Assistant Vice President Branch Manager BARCO/CURRITUCK Lewis G. Barnett Assistant Vice President Branch Manager HATTERAS R. Drew Pullen Vice President Branch Manager Cora A. Simmons Assistant Vice President Loan Officer MANTEO T. Olin Davis Vice President Branch Manager Susan H. Berry Vice President Loan Officer Roy O. "Chip" Phillips, Jr. Banking Officer NAGS HEAD Richard N. "Skipper" Hines, III Vice President Branch Manager Linda H. Algood Assistant Vice President Loan Officer OCRACOKE R. Drew Pullen Vice President Branch Manager Agnes G. Garrish Banking Officer Judith G. Garrish Banking Officer Branch Operations Manager SOUTHERN SHORES Thomas J. Kern Assistant Vice President Branch Manager* - - -------------------------------------------------------------------------------- WESTERN REGION Edwin J. "Jerry" Brett Vice President Western Region Manager GREENVILLE RED BANKS ROAD Barry G. Allen Assistant Vice President Branch Manager UNIVERSITY MEDICAL CENTER Mary M. Lawrence Branch Manager - - -------------------------------------------------------------------------------- Excellence in Community Banking 51 ATTORNEYS AND CORRESPONDENT BANKS [LOGO]-------------------------------------------------------------------------- The East Carolina Bank and Subsidiaries ATTORNEYS Davis & Davis Attorneys at Law Swan Quarter, North Carolina Ward and Smith, P.A. Attorneys at Law New Bern, North Carolina Charles W. Ogletree Attorney at Law Columbia, North Carolina - - -------------------------------------------------------------------------------- CORRESPONDENT BANKS Centura Bank Rocky Mount, North Carolina Federal Home Loan Bank of Atlanta Atlanta, Georgia Federal Reserve Bank of Richmond Charlotte Branch Charlotte, North Carolina Federal Reserve Bank of Richmond Richmond, Virginia First Citizens Bank & Trust Company Raleigh, North Carolina Bank of America Charlotte, North Carolina SunTrust Bank Atlanta, Georgia Wachovia Bank & Trust Company Winston-Salem, North Carolina - - -------------------------------------------------------------------------------- 52 EX-27 3 FDS -- ECB
9 12-MOS 12-MOS DEC-31-1998 DEC-31-1997 JAN-01-1998 JAN-01-1997 DEC-31-1998 DEC-31-1997 11,787 8,281 0 0 0 4,425 0 0 58,394 47,120 0 0 0 0 133,024 121,209 2,750 2,660 210,484 188,228 184,185 170,909 2,725 0 1,722 1,606 0 0 0 0 0 0 7,438 6,231 14,414 9,482 210,484 188,228 12,015 10,887 2,625 2,261 242 491 14,882 13,639 5,351 5,363 5,360 5,364 9,522 8,275 242 354 0 0 8,703 7,544 2,604 2,323 2,604 2,323 0 0 0 0 1,959 1,673 1.08 0.94 1.08 0.94 5.62 5.19 88 1,463 0 0 621 522 0 0 2,660 2,400 231 195 79 101 2,750 2,660 2,750 2,660 0 0 0 0
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