-----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, RbsjGjveaLDqSShpBf5ebcR7MRe4qZbSdR1GR2+KQuyfKeG032YdLXm+N7e/+och a7zSLYF3SO5bY1yH9tS17w== 0000912057-96-000830.txt : 19960126 0000912057-96-000830.hdr.sgml : 19960126 ACCESSION NUMBER: 0000912057-96-000830 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 2 FILED AS OF DATE: 19960125 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: SURETY CAPITAL CORP /DE/ CENTRAL INDEX KEY: 0000784932 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 752065607 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 033-64789 FILM NUMBER: 96507083 BUSINESS ADDRESS: STREET 1: 1845 PRECINCT LINE RD STE 100 CITY: HURST STATE: TX ZIP: 76054 BUSINESS PHONE: 8174988154 MAIL ADDRESS: STREET 1: 1845 PRECINCT LINE RD STE 100 CITY: HURST STATE: TX ZIP: 76054 FORMER COMPANY: FORMER CONFORMED NAME: K CAPITAL INC DATE OF NAME CHANGE: 19870407 S-1/A 1 FORM S-1/A AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 25, 1996 REGISTRATION NO. 33-64789 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------------- AMENDMENT NO. 1 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ SURETY CAPITAL CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 6021 75-2065607 (State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer of incorporation or Classification Code Number) Identification Number) organization)
1845 Precinct Line Road C. Jack Bean Suite 100 1845 Precinct Line Road Hurst, Texas 76054 Suite 100 (817) 498-2749 Hurst, Texas 76054 (Address, including zip code, and telephone (817) 498-2749 number, including area code, of registrant's (Name, address, including zip code, and telephone principal executive offices) number, including area code, of agent for service)
-------------------------- COPY TO: Dan R. Waller, P.C. SECORE & WALLER, L.L.P. One Galleria Tower, Suite 2290 13355 Noel Road, LB 75 Dallas, Texas 75240 (214) 776-0200 -------------------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER THE REGISTRATION STATEMENT BECOMES EFFECTIVE. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box. / / If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. / / If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. / / -------------------------- CALCULATION OF REGISTRATION FEE
PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE AGGREGATE REGISTRATION SECURITIES TO BE REGISTERED BE REGISTERED PER SHARE OFFERING PRICE FEE (1) Common stock, $0.01 per share par value..... 2,100,000 $ $7,841,400 $2,704
(1) The Registration fee is estimated based upon the average of the high and low market prices reported for the Common Stock of the Registrant carried on the Primary List of the American Stock Exchange during the week ended November 24, 1995, which was $3.734 per share. -------------------------- THE COMPANY HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SURETY CAPITAL CORPORATION FORM S-1 CROSS REFERENCE SHEET
ITEM NO. ITEM PROSPECTUS CAPTION OR PAGE - --------- -------------------------------------------------- ------------------------------------------------------- 1. Forepart of the Registration Statement and Outside Front Cover Page of Prospectus................... Facing Page of Registration Statement, ii, and 1 2. Inside Front and Outside Back Cover Pages of Prospectus....................................... 54 and back cover page 3. Summary Information............................... 2 3. Risk Factors...................................... 5 3. Ratios of Earnings to Fixed Charges............... Not Applicable 4. Use of Proceeds................................... 6 5. Determination of Offering Price................... Not applicable 6. Dilution.......................................... Not applicable 7. Selling Security Holders.......................... 51 8. Plan of Distribution.............................. 53 9. Description of Securities to be Registered........ 53 10. Interests of Named Experts and Counsel............ Not applicable 11. Information with Respect to the Registrant........ 7-50 12. Disclosure of Commission Position on Indemnification for Securities Act Liabilities... Not applicable
ii INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. SUBJECT TO COMPLETION, DATED JANUARY 25, 1996 PROSPECTUS 2,100,000 Shares Surety Capital Corporation Common Stock Of the 2,100,000 shares of Common Stock (the "Common Stock") offered hereby, 1,925,061 shares are being sold by Surety Capital Corporation (the "Company") and 174,939 shares are being sold by a shareholder of the Company (the "Selling Shareholder"). The Company will not receive any proceeds from the sale of shares by the Selling Shareholder. The Common Stock is traded on the American Stock Exchange ("AMEX") under the symbol "SRY". See "Market Price and Dividend Policy". On January 24, 1996 the last sale price of the Common Stock as reported on AMEX was $3.4375. The Company intends to use the proceeds of this Offering primarily to finance the Company's acquisition of First Midlothian Corporation, Midlothian, Texas and its subsidiary, First National Bank, and to retire the Company's outstanding indebtedness. Any remaining proceeds will be used for general corporate purposes. See "Use of Proceeds" and "The Midlothian Bank Acquisition". THE SHARES OF COMMON STOCK OFFERED HEREBY ARE NOT SAVINGS OR DEPOSIT ACCOUNTS AND ARE NOT INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE BANK INSURANCE FUND OR ANY OTHER GOVERNMENTAL AGENCY. SEE "INVESTMENT CONSIDERATIONS" FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY EACH PROSPECTIVE INVESTOR. ----------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. -------------------
PROCEEDS TO UNDERWRITING PROCEEDS TO SELLING PRICE TO PUBLIC DISCOUNT(1) COMPANY(2) SHAREHOLDER(3) Per Share..................... $ $ $ $ Total(4)...................... $ $ $ $
(1) The Company and the Selling Shareholder have agreed to indemnify the Underwriter against certain liabilities, including liabilities under the Securities Act of 1933, as amended (the "Securities Act"). See "Underwriting". (2) Before deducting offering expenses payable by the Company, estimated at $324,704. (3) Before deducting offering expenses payable by the Selling Shareholder, estimated at $30,000. (4) The Company has granted the Underwriter a 30-day option to purchase up to 288,759 additional shares of Common Stock, on the same terms and conditions as set forth above, solely to cover over-allotments, if any. If such option is exercised in full, the total Price to Public, Underwriting Discount and Proceeds to Company will be approximately $ , $ and $ , respectively. See "Underwriting". The shares of Common Stock are offered by the Underwriter when, as and if received and accepted by it, subject to its right to withdraw, cancel or reject orders in whole or in part and subject to certain other conditions. It is expected that delivery of the certificates representing the shares will be made against payment therefor on or about , 1996 in Dallas, Texas. HOEFER & ARNETT Incorporated The date of this Prospectus is , 1996. PROSPECTUS SUMMARY THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED INFORMATION AND FINANCIAL INFORMATION (INCLUDING THE NOTES THERETO) APPEARING ELSEWHERE IN THIS PROSPECTUS. AS USED IN THE PROSPECTUS, UNLESS THE CONTEXT OTHERWISE REQUIRES, THE TERM "COMPANY" MEANS SURETY CAPITAL CORPORATION AND ITS SUBSIDIARY. UNLESS OTHERWISE INDICATED, ALL INFORMATION IN THIS PROSPECTUS ASSUMES THAT THE UNDERWRITERS' OVER-ALLOTMENT OPTION IS NOT EXERCISED. THE COMPANY Surety Capital Corporation (the "Company") is a bank holding company headquartered in Hurst, Texas. The Company, which is a Delaware corporation, owns 99% of the outstanding shares of Surety Bank, National Association (the "Bank"). The Company operates full service banking offices in the Texas communities of Chester, Hurst, Kennard, Lufkin, Waxahachie, Wells, and Whitesboro. At September 30, 1995, the Company had $119.6 million in total assets, $108.2 million in deposits and $10.0 million in shareholders' equity. The Company's net income has grown from $16,424 in 1992 to $370,723 in 1993, $472,760 in 1994 and $648,413 for the nine months ended September 30, 1995. Additionally, since 1990 the Company's total assets have grown at an average annual rate of 40.4% while deposits have grown at a 48.4% average annual rate. This growth has been a result of a combination of internal growth in the Company's niche lending products and the Company's acquisition of community banks. Although the Company provides the traditional services of a community bank in its market areas, it has also attempted to distinguish itself by developing specialty products. The Company's primary niche product is insurance premium finance ("IPF") lending, which involves the lending of funds to companies and individuals for the purpose of financing their purchase of property and casualty insurance. The Company markets this product through over 3,000 independent insurance agents and maintains a loan portfolio representing nearly 400 insurance companies. At September 30, 1995, the Company reported total gross IPF loans of $24.3 million (34% of gross loans), a 16% increase over the December 31, 1994 total balance of $20.9 million in IPF loans (31.7% of gross loans). The loans are relatively short term, generally with maturities of eight to nine months, giving the Company flexibility with regard to its asset/liability strategy. The Company believes that the structure of these loans results in more limited credit losses than other types of loans. Specifically, the down payment and monthly installments on each loan are calculated such that at all times the equity or value of the unearned premium in the policy exceeds the net balance due on the loan. If the borrower does not make the loan payments on time, the Company has the right, after notice to the borrower, to cancel the insurance policy and to receive the entire amount of the unearned premium from the insurance company writing the insurance. The unearned premium is then applied to the loan balance. Since 1992, the Company has experienced no net loan losses on this product. See "Business -- Insurance Premium Financing". Another niche product in which the Company specializes is insurance medical claims factoring. The Company purchases medical claims from a variety of health care providers, including individual medical practices, medical clinics, hospital, and out-patient facilities. At September 30, 1995, the Company reported $3.0 million in medical claims receivable, representing 4.2% of total loans outstanding. The Company purchases only insurance company claims that have been pre-approved for payment by the insurance company, funding only 50%-60% of the face value of each claim to the provider. The collection period on these receivables is approximately 60 to 90 days. As of September 30, 1995, the Company has experienced no losses in this program, while realizing an annualized yield in excess of 18.1%. See "Business -- Medical Receivables Factoring". The Company funds these specialty lending products using core retail deposits from its network of community banking offices. For the nine months ended September 30, 1995, the Company's average cost of funds was 3.6% compared with a loan portfolio yield of over 11%. This relatively low cost of funds gives the Company a pricing advantage over non-bank competitors for its loan products. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Deposit Activities". 2 Since 1992, the Company has established five new full service branches by acquiring four community banks and purchasing a branch of another bank. Additionally, the Company has recently entered into an agreement to acquire the First Midlothian Corporation ("First Midlothian") and its subsidiary, First National Bank, Midlothian, Texas (the "Midlothian Bank"), which reported $52.1 million in total assets, $47.2 million in deposits and $3.8 million in shareholders' equity at September 30, 1995. The Company's strategy is to continue to acquire community banks with low loan-to-deposit ratios and use excess deposits to fund insurance premium finance and other niche lending products. See "The Midlothian Bank Acquisition". THE OFFERING Securities Offered by the Company............ 1,925,061 shares of Common Stock Securities Offered by Selling Shareholder.... 174,939 shares of Common Stock Common Stock to be Outstanding after the Offering.................................... 5,431,490 shares (1) Use of Proceeds.............................. The proceeds of this Offering will be used to finance the acquisition of First Midlothian and the Midlothian Bank, to repay indebtedness, and for general corporate purposes. See "Use of Proceeds". Investment Considerations.................... Prospective investors are advised to carefully review the matters discussed under "Investment Considerations". AMEX Symbol.................................. "SRY"
- ------------------------ (1) Excludes shares issuable upon the exercise of options under the Company's incentive stock option plans. See "Management -- Executive Compensation and Other Information". 3 SUMMARY CONSOLIDATED FINANCIAL DATA The following summary consolidated financial data of the Company is derived from the unaudited financial statements of the Company as of and for the nine month periods ended September 30, 1995 and 1994, and from the audited financial statements of the Company as of and for the five years ended December 31, 1994. The following summary consolidated financial data of the Company should be read in connection with the consolidated financial statements of the Company and the notes thereto and the information in Management's Discussion and Analysis of Financial Condition and Results of Operations.
NINE MONTHS ENDED YEARS ENDED SEPTEMBER 30, DECEMBER 31, ---------------------- ------------------------------------------------------- 1995 (1) 1994 (2) 1994 (2) 1993 (3) 1992 1991 1990 --------- ----------- --------- ----------- --------- --------- --------- INCOME STATEMENT DATA: ($ in 000's) Interest income............................... $ 6,872 $ 3,743 $ 5,387 $ 3,995 $ 3,344 $ 2,953 $ 2,175 Interest expense.............................. 2,537 972 1,488 1,124 978 1,380 1,071 Net interest income......................... 4,335 2,771 3,899 2,871 2,366 1,573 1,104 Provision for loan losses..................... 60 67 107 91 300 467 221 Net interest income after provision for loan losses..................................... 4,275 2,705 3,792 2,781 2,067 1,107 883 Noninterest income............................ 1,056 801 1,160 1,182 784 488 455 Noninterest expense........................... 4,382 3,205 4,462 3,592 2,835 2,185 1,933 Extraordinary item - gain on debt settlement.. -- -- -- -- -- -- 517 Earnings before income taxes.................. 949 301 490 371 16 (590) (78) Income taxes.................................. 301 8 17 -- -- -- -- Net earnings (loss)........................... $ 648 $ 294 $ 473 $ 371 $ 16 $ (590) $ (78) COMMON SHARE DATA: (4) Net earnings (loss)........................... $ 0.20 $ 0.13 $ 0.20 $ 0.19 $ 0.00 $ (0.45) $ (0.08) Book value.................................... 2.85 2.52 2.65 2.32 2.05 1.85 1.43 Weighted average common shares outstanding (in 000's)....................................... 3,208 2,344 2,394 2,002 1,952 1,310 963 Period end shares outstanding (in 000's)...... 3,506 2,373 3,041 2,273 1,981 1,767 988 BALANCE SHEET DATA: ($ in 000's) Total assets.................................. $ 119,554 $ 61,784 $ 102,294 $ 49,036 $ 30,964 $ 26,877 $ 22,088 Insurance premium finance loans, net.......... 23,724 20,254 20,497 14,209 7,051 8,016 6,801 Other loans, net.............................. 44,924 19,509 44,167 17,417 12,442 11,242 8,388 Allowance for loan losses..................... 725 407 698 401 325 343 277 Total deposits................................ 108,209 55,552 92,027 43,596 26,840 23,335 20,012 Shareholders' equity.......................... 10,037 5,969 8,066 5,281 4,058 3,263 1,409 PERFORMANCE DATA: (5) Return (loss) on average total assets......... .9% .7% .8% .8% .1% (2.3)% (.4)% Return (loss) on average shareholders' equity....................................... 9.6 6.8 7.4 8.7 .4 (30.4) (7.2) Net interest margin........................... 6.3 7.4 7.1 7.0 8.7 7.0 7.0 Loans to deposits............................. 63.4 71.6 70.3 72.5 72.6 82.5 75.9 ASSET QUALITY RATIOS: (5) Nonperforming assets to total assets.......... .1% .1% .2% .3% .7% 2.1% 3.8% Nonperforming loans to total loans............ .1 .1 .2 .3 .8 2.4 5.3 Net loan charge-offs to average loans......... .1 .3 .4 .3 1.6 2.3 .5 Allowance for loan losses to total loans...... 1.1 1.0 1.1 1.3 1.7 1.8 1.8 Allowance for loan losses to nonperforming loans........................................ 1,772.5 456.9 574.8 425.8 201.1 74.8 34.8 CAPITAL RATIOS: Tier I risk-based capital..................... 10.17% 10.97% 10.13% 11.37% 14.44% 13.2% 5.3% Total risk-based capital...................... 11.14 11.73 11.17 12.57 15.69 14.7 6.8 Leverage...................................... 6.4 8.5 5.6 10.0 11.9 10.9 4.6
- ---------------------------------- (1) On September 28, 1995 the Company completed the acquisition of certain assets and the assumption of certain liabilities relating to the branch of Bank One, Texas, National Association located in Waxahachie, Texas. (2) On May 31, 1994 the Company acquired 100% of the outstanding common stock of The Farmers Guaranty State Bank of Kennard, Kennard, Texas, and on December 8, 1994 the Company acquired 100% of the outstanding common stock of First National Bank, Whitesboro, Texas. (3) On March 23, 1993 the Company acquired 100% of the outstanding common stock of the Bank of East Texas, Chester, Texas and First State Bank, Wells, Texas. Operations of these two banks have been included in consolidated operations subsequent to February 28, 1993. (4) The information provided for 1990, 1991 and 1992 has been restated to reflect a one for ten reverse stock split in June 1993. (5) All interim periods have been annualized. 4 INVESTMENT CONSIDERATIONS IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS PROSPECTUS, THE FOLLOWING FACTORS SHOULD BE CONSIDERED CAREFULLY IN EVALUATING THE COMPANY, ITS BUSINESS AND PROSPECTS BEFORE PURCHASING ANY OF THE SHARES OF COMMON STOCK OFFERED HEREBY. INSURANCE PREMIUM FINANCING CONCENTRATION. As of September 30, 1995, IPF loans represented approximately 34% of the gross loans of the Company. Such a high concentration of IPF loans may expose the Company to a greater risk of loss than would a more diversified loan portfolio. Losses or other difficulties encountered by any one insurance company could have a material adverse effect on the Company. In addition, regulatory or structural changes affecting the insurance industry generally may have a material adverse effect on the Company. The Company extends IPF loans with an average maturity of nine months. Most of these loans are repaid in monthly installments. If the Company is unable to generate new IPF loans to replace those being repaid, it will have to originate other types of loans or make other investments, some or all of which may not be as profitable for the Company. As the Company expands through acquisitions such as the Midlothian Bank, the Company must increase the aggregate amount of IPF loans originated on a continuous basis in order to maintain its current net interest margin. See "Business -- Insurance Premium Financing". ADDITIONAL FINANCING. The Company has in the past expanded through acquisitions, and has financed its recent acquisitions primarily through offerings of the Company's Common Stock. There can be no assurance that the Company will continue to expand as rapidly in the future or will continue to make acquisitions. However, if the Company does make additional acquisitions, it is likely to finance the acquisitions through offerings of its stock. If the Company does sell additional shares of common and/or preferred stock to raise funds in the future, the terms and conditions of the issuances may have a dilutive effect or otherwise adversely impact existing shareholders. RELIANCE ON KEY PERSONNEL. The Company and the Bank are dependent upon their executive officers and key employees. Specifically, the Company considers the services of C. Jack Bean, G. M. Heinzelmann, III, and Bobby W. Hackler to be important to the success of the Company. The unexpected loss of the services of any of these individuals could have a detrimental effect on the Company and the Bank. The Company has entered into Change in Control Agreements with Messers. Bean, Heinzelmann and Hackler under which each will receive certain benefits if their employment is terminated other than for cause, or constructively terminated, following a change in control of the Company. See "Management". DIVIDEND HISTORY. The Company has not previously paid any cash dividends on its Common Stock, and the Company does not intend to pay dividends in the near future. The payment of any cash dividends by the Company in the future will depend to a large extent on the receipt of dividends from the Bank. The ability of the Bank to pay dividends is dependent upon the Bank's earnings and financial condition. The payment of cash dividends by the Bank to the Company and by the Company to its shareholders are both subject to certain statutory and regulatory restrictions. See "Market Price and Dividend Policy" and "Regulation and Supervision". COMPETITION. There is significant competition among banks and bank holding companies, many of which have far greater assets and resources than the Company, in the areas in which the Company operates. The Company also encounters intense competition in its commercial banking business from savings and loan associations, credit unions, factors, insurance companies, commercial and captive finance companies, and certain other types of financial institutions located in other major metropolitan areas in the United States, many of which are larger in terms of capital, resources and personnel than the Company. The casualty IPF business of the Company is also very competitive. Large insurance companies offer their own financing plans, and other independent premium finance companies and other financial institutions offer IPF. The Company believes that such competition will continue and increase in the future. In addition, the manner in which and the means by which financial services are delivered to customers have changed significantly in the past and can be expected to continue to change in the future. It is not possible to predict the manner in which existing technology, and changes in existing technology, will affect the Company. Changes in technology are 5 likely to require additional capital investments to remain competitive. Although the Company has invested in new technology in the past, there can be no assurance that the Company will have sufficient financial resources or access to the proprietary technology which might be necessary to remain competitive in the future. See "Business -- Competition". REGULATION AND SUPERVISION. The Company and the Bank are subject to extensive federal and state regulation and supervision, which is intended primarily for the protection of insured depositors and consumers. In addition, the Company and the Bank are subject to changes in federal and state law, as well as changes in regulations, governmental policies and accounting principles. The effects of any such potential changes cannot be predicted, but could adversely affect the business and operations of the Company and the Bank. See "Regulation and Supervision". REGULATION OF CONTROL. Individuals, alone or acting in concert with others, seeking to acquire more than 10% of any class of voting securities of the Company must comply with the Change in Bank Control Act. Entities seeking to acquire 5% or more of any class of voting securities of, or otherwise to control, the Company must comply with the Bank Holding Company Act. Accordingly, prospective investors need to be aware of these requirements and to comply with these requirements, if applicable, in connection with any purchase of shares of the Common Stock offered hereby. GENERAL ECONOMIC CONDITIONS AND MONETARY POLICY. The operating income and net income of the Company depend to a substantial extent on "rate differentials", i.e., the differences between the income the Company receives from loans, securities and other earning assets, and the interest expense it pays to obtain deposits and other liabilities. These rates are highly sensitive to many factors which are beyond the control of the Company, including general economic conditions and the policies of various governmental and regulatory authorities. For example, in an expanding economy, loan demand usually increases and the interest rates charged on loans increase. Increases in the discount rate by the Federal Reserve System usually lead to rising interest rates, which affect the Company's interest income, interest expense and investment portfolio. Also, governmental policies such as the creation of a tax deduction for individual retirement accounts can increase savings and affect the cost of funds. TRADING MARKET FOR THE COMMON STOCK. Although the Common Stock is listed for trading on the American Stock Exchange, the trading market in the Company's Common Stock on such exchange historically has been less active than the average trading market for companies listed on such exchange. As a result, the price of the Company's Common Stock has ranged from $3.063 to $6.75 during the first nine months of 1995. A public trading market having the desired characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace of willing buyers and sellers of Common Stock at any given time, which presence is dependent upon the individual decisions of investors and general economic and market conditions over which the Company has no control. Consequently, although the Company believes that this Offering will improve the liquidity of the market for the Common Stock, no assurance can be given that this Offering will increase the volume of trading in the Common Stock. See "Market Price and Dividend Policy". USE OF PROCEEDS The Company has entered into an agreement to acquire First Midlothian, and its wholly-owned subsidiary, the Midlothian Bank. In connection with the acquisition, the shareholders of First Midlothian will receive cash for their shares in that corporation. The Company intends to use the net proceeds from the sale of Common Stock to finance this acquisition. The Company also intends to use approximately $375,000 of the net proceeds to retire its outstanding debt. Any remaining proceeds will be used by the Company for general corporate purposes. See "The Midlothian Bank Acquisition -- Pro Forma Financial Statements". 6 CAPITALIZATION The following table sets forth the unaudited consolidated capitalization of the Company as of September 30, 1995, and the pro forma capitalization adjusted to reflect (i) the sale by the Company of the Common Stock offered hereby; (ii) the consummation of the acquisition of the Midlothian Bank; and (iii) the application of net proceeds as described under "Use of Proceeds".
SEPTEMBER 30, 1995 ---------------------------- PRO FORMA AS ACTUAL ADJUSTED ------------- ------------- Note payable................................................... $ 375,000 $ 0 Shareholders' equity: Common stock, $.01 par value; Authorized -- 20,000,000 shares; Issued -- 3,516,595 shares, (5,441,656 as adjusted)................................................... 35,166 54,417 Additional paid-in capital................................... 9,364,515 15,734,210 Retained earnings............................................ 573,311 573,311 Treasury stock............................................... (50,830) (50,830) Unrealized gain on available-for-sale securities............. 114,539 114,539 ------------- ------------- Total shareholders' equity................................. $ 10,036,701 $ 16,425,647 ------------- ------------- ------------- -------------
MARKET PRICE AND DIVIDEND POLICY MARKET PRICE Since January 10, 1995 the Company's Common Stock has been traded on the Primary List of the AMEX under the symbol "SRY". From February 23, 1994 through January 9, 1995 the Company's Common Stock was traded on the AMEX Emerging Company Marketplace under the symbol "SRY.EC". Prior to February 23, 1994, the Company's Common Stock was traded in the over-the-counter market on the National Association of Securities Dealers Automated Quotation System ("NASDAQ"). The following table sets forth, for the periods indicated, the high and low sale price per share of the Company's Common Stock as reported on the AMEX Primary List since January 10, 1995, and on the AMEX Emerging Company Marketplace from February 23, 1994, until January 9, 1995, and the high and low bid price per share as reported by NASDAQ for prior periods. All prices have been adjusted to reflect a one-for-ten reverse stock split effected by the Company on June 14, 1993. The NASDAQ quotations reflect prices quoted by market makers of the Company's Common Stock, without retail markup, markdown or commissions, and may not necessarily represent actual transactions.
HIGH LOW --------- --------- 1994 FISCAL YEAR: First quarter.............................................................. $ 6.38 $ 3.00 Second quarter............................................................. 5.25 3.88 Third quarter.............................................................. 5.00 4.00 Fourth quarter............................................................. 4.50 3.00 1995 FISCAL YEAR: First quarter.............................................................. 4.38 3.06 Second quarter............................................................. 6.75 3.19 Third quarter.............................................................. 5.13 3.50 Fourth quarter (through November 30)....................................... 5.00 3.63
DIVIDEND POLICY THE COMPANY. The Company has not paid cash dividends in the past and does not intend to pay dividends for the foreseeable future. The Company intends to retain any future earnings for use in the business of the Company and the Bank. The payment of any dividends in the future will be made at the discretion of the Board of Directors of the Company and will depend upon the operating results and 7 financial condition of the Company and the Bank, their capital requirements, contractual agreements, general business conditions and other factors. The Company's principal source of funds to pay dividends in the future, if any, on the Common Stock will be cash dividends the Company receives from the Bank. See "Regulation and Supervision" for a discussion of regulatory constraints on the payment of dividends by national banks and bank holding companies generally. THE BANK. The Bank is subject to various restrictions imposed by the National Bank Act relating to the declaration and payment of dividends. The board of directors of a national banking association may, subject to the following limitations, declare a quarterly, semiannual or annual dividend of as much of its net profits as it may judge expedient. The payment of dividends is subject to the provisions of 12 U.S.C. 60, which provides that no dividends may be declared or paid without the approval of the Office of the Comptroller of the Currency ("OCC") if the total of all dividends, including the proposed dividend, in any calendar year exceeds the total of the national banking association's net profits for that year combined with its retained net profits of the preceding two years. Under the provisions of 12 U.S.C. 56 no dividends may ever be paid in an amount greater than the bank's net profits. The OCC also has authority to prohibit a national bank from engaging in what in the OCC's opinion constitutes an unsafe or unsound practice in conducting business, including the payment of a dividend. See "Regulation and Supervision" for a discussion of regulatory constraints on the payment of dividends by national banks and bank holding companies generally. THE MIDLOTHIAN BANK ACQUISITION THE REORGANIZATION AGREEMENT The Company intends to acquire First Midlothian and its subsidiary, the Midlothian Bank. The Company and the Bank have entered into a reorganization agreement dated October 17, 1995 with First Midlothian, the Midlothian Bank, and the directors of the Midlothian Bank in both their individual and representative capacities ("Reorganization Agreement"). Under the Reorganization Agreement, an operating subsidiary of the Bank (to be formed) will be merged with and into First Midlothian, and the shareholders of First Midlothian will receive cash in the aggregate amount of (i) 150% of the book value of the Midlothian Bank, as of the closing date, up to a book value of $4.5 million plus (ii) 100% of the book value of the Midlothian Bank, as of the closing date, in excess of $4.5 million minus (iii) all outstanding principal and accrued interest on debentures issued by First Midlothian. Immediately following the merger of the operating subsidiary of the Bank and First Midlothian, the Bank and the Midlothian Bank will be consolidated under the charter of the Bank. The Reorganization Agreement provides that in the calculation of the purchase price, the book value of the Midlothian Bank will be decreased by audit fees, agent fees and one-half the cost of canceling the Midlothian Bank's data processing contract, estimated in the aggregate at $272,500. The purchase price paid by the Company will be increased by one-half the cost of canceling the Midlothian Bank's data processing contract. The total cost to cancel the contract is estimated at $125,000. If the acquisition had been completed on September 30, 1995, the purchase price paid to the shareholders of First Midlothian would have been approximately $5.4 million. The obligations of the parties to complete the acquisition are subject to certain conditions, including the conditions that (i) all approvals of any regulatory authority having jurisdiction shall have been received and all applicable statutory waiting periods shall have expired; and (ii) at the closing date, no litigation shall be pending or threatened to restrain or prohibit or obtain damages regarding the acquisition or as a result of which, in the reasonable judgment of the Company or First Midlothian, the parties could be deprived of any of the material benefits contemplated under the Reorganization Agreement. In addition, the Company and the Bank are not obligated to complete the acquisition unless certain conditions set out in the Reorganization Agreement have been satisfied or waived by the Company and the Bank, including that (i) the shareholders of First Midlothian shall have approved the transactions contemplated under the Reorganization Agreement; (ii) neither First Midlothian nor the Midlothian Bank shall have, in the opinion of the Company and the Bank, suffered any material adverse change in their financial condition, business, operations, prospects, properties or assets; (iii) holders of no more than 5% of the outstanding shares of First Midlothian shall have dissented from the merger of First Midlothian and the Bank's operating subsidiary; 8 and (iv) the Company shall have sufficient financial resources available, in its sole opinion, to consummate the acquisition. The directors of First Midlothian, First Midlothian, and the Midlothian Bank are not obligated to complete the transaction if certain conditions are not met, including the condition that the shareholders of the Bank shall have approved the consolidation of the Bank and the Midlothian Bank contemplated under the Reorganization Agreement. The directors of First Midlothian have agreed, in their individual and representative capacities, jointly and severally, that they shall be responsible for all federal, state and local income, franchise and other tax liabilities of First Midlothian or Midlothian Bank for all periods prior to the acquisition. In addition, they shall be responsible for payment of federal income and Texas franchise tax liabilities incurred by the Company, the Bank, First Midlothian or the Midlothian Bank as a result of the acquisition and the subsequent liquidation of First Midlothian being held to be a taxable acquisition or disposition of assets or other taxable transaction. If the Company elects to terminate the Reorganization Agreement because, in its opinion, it does not have sufficient financial resources available to complete the acquisition, the Company is obligated to pay First Midlothian a break-up fee of a minimum of $25,000, if the election is made before December 31, 1995, and a maximum of $50,000, if the election is made before June 30, 1996. The closing date of the acquisition will be selected by mutual agreement of the parties to the Reorganization Agreement following the satisfaction of all conditions to closing. The Company anticipates that the closing will take place substantially contemporaneously with the closing of this Offering. BUSINESS OF FIRST MIDLOTHIAN First Midlothian is a Texas corporation located in Midlothian, Texas. First Midlothian engages in no significant activities other than owning and managing the Midlothian Bank. First Midlothian has 48,000 shares of common stock issued and outstanding. The directors who individually and as a group approved and executed the Reorganization Agreement are the record and beneficial owners of approximately 42% of the outstanding common stock of First Midlothian. At September 30, 1995, First Midlothian had total consolidated assets of approximately $52.1 million, total consolidated deposits of approximately $47.2 million, and total consolidated shareholders' equity of approximately $3.8 million. First Midlothian had $674,707 in principal amount of debentures issued and outstanding at September 30, 1995. The Reorganization Agreement contemplates that First Midlothian will be liquidated, and the debentures repaid by First Midlothian, following the acquisition. First Midlothian's subsidiary, the Midlothian Bank, is a community bank which offers interest and noninterest bearing depository accounts, and makes consumer and commercial loans. As September 30, 1995, the Midlothian Bank's loan portfolio consisted of $12.4 million of real estate loans (60% of the gross loan portfolio), $4.2 million of commercial loans (20% of the gross loan portfolio), and $4.0 million of installment loans (19% of the gross loan portfolio). At September 30, 1995, the Midlothian Bank's total nonaccrual loans were $128,621 (0.6% of the gross loan portfolio). The allowance for possible loan losses was $230,615, or 179% of total nonaccruing loans, and 1.1% of the gross loan portfolio. Other real estate owned by the Midlothian Bank was $713,268 at September 30, 1995. Midlothian Bank reported net income after taxes of $274,943 for 1994, and $306,264 for the nine months ended September 30, 1995. See the consolidated financial statements of First Midlothian included in this prospectus. PRO FORMA FINANCIAL STATEMENTS The following pro forma financial statements set forth the consolidated balance sheets at September 30, 1995 and income statements for the nine months ended September 30, 1995 and for the year ended December 31, 1994 for the Company and First Midlothian, the adjustments reflecting the proposed acquisition, and the pro forma combined information. The information with respect to the Company as of September 30, 1995 and the pro forma information are unaudited. The pro forma balance sheet assumes that the acquisition was consummated on September 30, 1995. The pro forma income statements assume that the acquisition was consummated at the beginning of the periods indicated. The pro forma financial statements should be read in conjunction with the financial statements and footnotes thereto appearing elsewhere in this prospectus. The pro forma combined balance sheet and statement of income are not necessarily indicative of the combined financial position at consummation or the results of operations following consummation. 9 PRO FORMA BALANCE SHEET AS OF SEPTEMBER 30, 1995
SURETY FIRST CAPITAL MIDLOTHIAN PRO FORMA CORPORATION CORPORATION DEBITS CREDITS COMBINED ------------ --------------- -------------- ---------- ------------ (UNAUDITED) (UNAUDITED) ASSETS: Cash and due from banks......................... $ 4,997,517 $ 3,586,274(B) $6,013,946(A) $6,051,946 $ 8,545,791 Federal funds sold.............................. 21,660,000 7,100,000 28,760,000 ------------ --------------- ------------ Cash and cash equivalents..................... 26,657,517 10,686,274 6,013,946 6,051,946 37,305,791 Interest bearing deposits in financial institutions................................... 1,334,860 -- 1,334,860 Investment securities........................... 17,017,258 19,309,212(C) 40,336 36,366,806 Net loans....................................... 67,923,543 20,094,209 88,017,752 Premises and equipment, net..................... 2,776,443 861,532(D) 319,468 3,957,443 Accrued interest receivable..................... 622,518 429,114 1,051,632 Other real estate and repossessed assets........ 92,830 653,035 745,865 Other assets.................................... 594,762 96,866 691,628 Excess of cost over fair value of net assets acquired, net.................................. 2,534,050 --(A) 1,254,334 3,788,384 ------------ --------------- -------------- ---------- ------------ Total assets................................ $119,553,781 $52,130,242 $7,628,084 $6,051,946 $173,260,161 ------------ --------------- -------------- ---------- ------------ ------------ --------------- -------------- ---------- ------------ LIABILITIES: Demand deposits................................. $ 13,914,468 $10,154,310 $ -- $ -- $ 24,068,778 Savings, NOW and money markets.................. 31,421,332 16,729,861 48,151,193 Time deposits, $100,000 and over................ 13,885,925 1,963,600 15,849,525 Other time deposits............................. 48,986,950 18,312,770 67,299,720 ------------ --------------- ------------ Total deposits.............................. 108,208,675 47,160,541 155,369,216 Note payable.................................... 375,000 674,707(A) 1,049,707 -- Federal income tax payable...................... 254,386 -- 254,386 Accrued interest payable........................ 679,019 531,893 1,210,912 ------------ --------------- -------------- ---------- ------------ Total liabilities........................... 109,517,080 48,367,141 1,049,707 156,834,514 ------------ --------------- -------------- ---------- ------------ SHAREHOLDERS' EQUITY: Common stock.................................... 35,166 480,000(A) 480,000(B) 19,251 54,417 Additional paid in capital...................... 9,364,515 679,493(A) 679,493(B) 6,369,695 15,734,210 Retained earnings............................... 573,311 2,603,608(A) 2,603,608 573,311 Treasury stock.................................. (50,830) -- (50,830) Unrealized gain (loss) on available-for-sale securities..................................... 114,539 -- 114,539 ------------ --------------- -------------- ---------- ------------ Total equity................................ 10,036,701 3,763,101 4,812,808 6,388,946 16,425,647 ------------ --------------- -------------- ---------- ------------ Total liabilities and equity.............. $119,553,781 $52,130,242 $4,812,808 $6,388,946 $173,260,161 ------------ --------------- -------------- ---------- ------------ ------------ --------------- -------------- ---------- ------------
- -------------------------- (A) To record the purchase of First Midlothian. The shareholders of First Midlothian will receive 150% of the book value of the Midlothian Bank at closing, up to a book value of $4.5 million, plus 100% of any book value in excess of $4.5 million, plus 50% of the cost to cancel an EDS data processing contract, (estimated at $62,500), minus the total principal and accrued interest attributable to debt issued by First Midlothian. The book value of the Midlothian Bank will be the total equity less 50% of the cost to cancel a contract with EDS, less $40,000 for estimated audit fees and less $170,000 for agent fees. Thus, if the acquisition had been consummated as of September 30, 1995, the purchase price would have been calculated as follows: (($4,265,464 - 62,500 - 40,000 - 170,000) X 1.5) + 62,500 = $6,051,946. First Midlothian will pay off its debt with part of the proceeds of the purchase price. The difference between the purchase price and the value of the assets purchased, estimated at $1,254,334, is recorded as goodwill and is amortized over a 15 year period. The Company anticipates that the book value of the Midlothian Bank will be increased through the retention of earnings prior to closing. (B) To record $6,500,000 net capital raised through the offering and the payoff of the Company's debt of $375,000. (C) In order to adjust investment securities to estimated market value an increase of $40,336 is recorded. (D) In order to adjust property and equipment to estimated market value an increase of $319,468 is recorded. 10 PRO FORMA INCOME STATEMENT FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995
PRO FORMA SURETY FIRST ADJUSTMENTS CAPITAL MIDLOTHIAN ------------------------------ PRO FORMA CORPORATION CORPORATION DEBITS CREDITS COMBINED ------------ ------------ -------------- -------------- ------------ (UNAUDITED) Interest Income: Commercial loans and real estate loans...... $ 2,759,887 $ 1,240,594 $ -- $ -- $ 4,000,481 Consumer loans.............................. 861,646 296,496 1,158,142 Insurance premium financing................. 2,080,915 -- 2,080,915 Federal funds sold.......................... 358,600 320,679 679,279 Investment securities and interest bearing deposits................................... 810,719 866,236 1,676,955 Other interest income....................... -- 1,757 1,757 ------------ ------------ -------------- -------------- ------------ Total interest income................... 6,871,767 2,725,762 9,597,529 ------------ ------------ -------------- -------------- ------------ Interest expense: Savings, NOW and money market............... 569,783 368,646 938,429 Time deposits, $100,000 and over............ 579,022 202,403 781,425 Other time deposits......................... 1,276,222 595,985 1,872,207 Other interest expense...................... 111,915 68,011 179,926 ------------ ------------ -------------- -------------- ------------ Total interest expense.................. 2,536,942 1,235,045 3,771,987 ------------ ------------ -------------- -------------- ------------ Net interest income before provision for loan losses................................ 4,334,825 1,490,717 5,825,542 Provision for loan losses................... 60,000 35,000 95,000 ------------ ------------ -------------- -------------- ------------ Net interest income..................... 4,274,825 1,455,717 5,730,542 ------------ ------------ -------------- -------------- ------------ Non interest income........................... 1,056,095 469,788 1,525,883 ------------ ------------ -------------- -------------- ------------ Non interest expense: Salaries and employee benefits.............. 2,143,694 720,361 2,864,055 Occupancy & equipment....................... 668,483 156,170 7,987(C) 832,640 General & administrative.................... 1,569,753 592,140 335,217(B) 159,300(A) 2,337,810 ------------ ------------ -------------- -------------- ------------ Total noninterest expense............... 4,381,930 1,468,671 343,204 159,300 6,034,505 ------------ ------------ -------------- -------------- ------------ Income before income taxes.............. 948,990 456,834 343,204 159,300 1,221,920 Income tax expense: Current..................................... 300,577 50,498(D) 108,796(D) 242,279 Deferred.................................... -- 150,570 150,570 ------------ ------------ -------------- -------------- ------------ Net income.............................. $ 648,413 $ 306,264 $ 393,702(F) $ 268,096(F) $ 829,071 ------------ ------------ -------------- -------------- ------------ ------------ ------------ -------------- -------------- ------------ Net income per share of common stock.......... $ 0.20 $ 0.16 ------------ ------------ ------------ ------------ Weighted average shares outstanding........... 3,208,319 5,133,380(E) ------------ ------------ ------------ ------------
- ------------------------ (A) To record savings to be realized in connection with the acquisition. These adjustments are a direct result of the elimination of director fees, committee fees and professional fees which will not continue after the acquisition. In addition to the elimination of these fees, a reduction in computer processing fees is also recorded. (B) To record amortization of the Goodwill recorded in connection with the acquisition of First Midlothian for the nine months ended September 30, 1995 and to record payment of fees by First Midlothian (i.e. agent's fee of $170,000, First Midlothian's share of the estimated cost to cancel the EDS contract of $62,500 and estimated audit fee of $40,000). (C) To record the additional depreciation to premises and equipment as a result of the write up to estimated market value for First Midlothian for the nine months ended September 30, 1995. (D) To record tax effect of adjustments. (E) The additional shares offered hereby (1,925,061 shares) increase total outstanding shares. (F) This pro forma income statement does not reflect all adjustments to, or projected changes in, income the Bank expects to realize following consummation of the acquisition. The pro forma income statement reflects known and quantifiable adjustments if the acquisition had been completed on September 30, 1995. 11 PRO FORMA INCOME STATEMENT FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1994
PRO FORMA SURETY FIRST ADJUSTMENTS CAPITAL MIDLOTHIAN ------------------------------ PRO FORMA CORPORATION CORPORATION DEBITS CREDITS COMBINED ------------ ------------ -------------- -------------- ---------------- (UNAUDITED) (UNAUDITED) Interest Income: Commercial loans and real estate loans....... $ 1,422,911 $ 1,466,820 $ -- $ -- $ 2,889,731 Consumer loans............................... 1,059,188 351,874 1,411,062 Insurance premium financing.................. 2,172,038 -- 2,172,038 Federal funds sold........................... 302,621 185,581 488,202 Investment securities and interest bearing deposits.................................... 430,251 963,043 1,393,294 Other interest income........................ -- 32,621 32,621 ------------ ------------ -------------- -------------- ---------------- Total interest income.................... 5,387,009 2,999,939 8,386,948 ------------ ------------ -------------- -------------- ---------------- Interest expense: Savings, NOW and money market................ 353,123 327,632 680,755 Time deposits, $100,000 and over............. 362,700 134,369 497,069 Other time deposits.......................... 760,833 627,142 1,387,975 Other interest expense....................... 11,075 81,777 92,852 ------------ ------------ -------------- -------------- ---------------- Total interest expense................... 1,487,731 1,170,920 2,658,651 ------------ ------------ -------------- -------------- ---------------- Net interest income before provision for loan losses...................................... 3,899,278 1,829,019 5,728,297 Provision for loan losses.................... 106,899 -- 106,899 ------------ ------------ -------------- -------------- ---------------- Net interest income...................... 3,792,379 1,829,019 5,621,398 ------------ ------------ -------------- -------------- ---------------- Non interest income............................ 1,160,007 627,846 1,787,853 ------------ ------------ -------------- -------------- ---------------- Non interest expense: Salaries and employee benefits............... 2,201,188 941,462 3,142,650 Occupancy & equipment........................ 669,936 194,860 10,649(C) 875,445 General & administrative..................... 1,590,814 936,371 356,122(B) 212,400(A) 2,670,907 ------------ ------------ -------------- -------------- ---------------- Total noninterest expense................ 4,461,938 2,072,693 366,771 212,400 6,689,002 ------------ ------------ -------------- -------------- ---------------- Income before income taxes............... 490,448 384,172 366,771 212,400 720,249 Income tax expense: Current...................................... 36,697 -- 67,331(E) 116,266(E) (12,239) Deferred..................................... (19,009) 109,229 90,220 ------------ ------------ -------------- -------------- ---------------- Net income................................. $ 472,760 $ 274,943 $ 434,102(D) $ 328,666(D) $ 642,268 ------------ ------------ -------------- -------------- ---------------- ------------ ------------ -------------- -------------- ---------------- Net income per share of common stock........... $ 0.20 $ 0.15 ------------ ---------------- ------------ ---------------- Weighted average shares outstanding............ 2,393,841 4,318,902 (F) ------------ ---------------- ------------ ----------------
- ------------------------ (A) To record savings to be realized by the acquisition. These adjustments are a direct result of the elimination of director, committee and professional fees which will not continue after the consolidation. In addition to the elimination of these fees, a reduction in computer processing fees is also recorded. (B) To record amortization of the goodwill added through the acquisition of First Midlothian for the year ended December 31, 1994 and to record payment of fees by First Midlothian (i.e. agent's fee of $170,000, First Midlothian's share of the estimated cost to cancel the EDS contract of $62,500 and estimated audit fee of $40,000). (C) To record the additional depreciation to premises and equipment as a result of the write up to estimated market value for First Midlothian for the year ended December 31, 1994. (D) This pro forma income statement does not reflect all adjustments to, or projected changes in, income the Company expects to realize following consummation of the acquisition. (E) To record tax effect of adjustments. (F) The additional shares offered hereby (1,925,061 shares) increase total outstanding shares. 12 SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data of the Company is derived from the unaudited financial statements of the Company as of and for the nine month periods ended September 30, 1995 and 1994, and from the audited financial statements of the Company as of and for the five years ended December 31, 1994. The following selected consolidated financial data of the Company should be read in connection with the consolidated financial statements of the Company and the notes thereto and the information in Management's Discussion and Analysis of Financial Condition and Results of Operations.
NINE MONTHS ENDED SEPTEMBER 30, YEARS ENDED DECEMBER 31, -------------------- ----------------------------------------------------- 1995 (1) 1994 (2) 1994 (2) 1993 (3) 1992 1991 1990 --------- -------- --------- -------- -------- -------- -------- INCOME STATEMENT DATA: ($ in 000's) Interest income................................. $ 6,872 $ 3,743 $ 5,387 $ 3,995 $ 3,344 $ 2,953 $ 2,175 Interest expense................................ 2,537 972 1,488 1,124 978 1,380 1,071 Net interest income........................... 4,335 2,771 3,899 2,871 2,366 1,573 1,104 Provision for loan losses....................... 60 67 107 91 300 467 221 Net interest income after provision for loan losses....................................... 4,275 2,705 3,792 2,781 2,067 1,107 883 Noninterest income.............................. 1,056 801 1,160 1,182 784 488 455 Noninterest expense............................. 4,382 3,205 4,462 3,592 2,835 2,185 1,933 Extraordinary item -- gain on debt settlement... -- -- -- -- -- -- 517 Earnings before income taxes.................... 949 301 490 371 16 (590) (78) Income taxes.................................... 301 8 17 -- -- -- -- Net earnings (loss)............................. $ 648 $ 294 $ 473 $ 371 $ 16 $ (590) $ (78) COMMON SHARE DATA: (4) Net earnings (loss)............................. $ 0.20 $ 0.13 $ 0.20 $ 0.19 $ 0.00 $ (0.45) $ (0.08) Book value...................................... 2.85 2.52 2.65 2.32 2.05 1.85 1.43 Weighted average common shares outstanding (in 000's)......................................... 3,208 2,344 2,394 2,002 1,952 1,310 963 Period end shares outstanding (in 000's)........ 3,506 2,373 3,041 2,273 1,981 1,767 988 BALANCE SHEET DATA: ($ in 000's) Total assets.................................... $119,554 $61,784 $102,294 $49,036 $30,964 $26,877 $22,088 Insurance premium finance loans, net............ 23,724 20,254 20,497 14,209 7,051 8,016 6,801 Other loans, net................................ 44,924 19,509 44,167 17,417 12,442 11,242 8,388 Allowance for loan losses....................... 725 407 698 401 325 343 277 Total deposits.................................. 108,209 55,552 92,027 43,596 26,840 23,335 20,012 Shareholders' equity............................ 10,037 5,969 8,066 5,281 4,058 3,263 1,409 PERFORMANCE DATA: (5) Return (loss) on average total assets........... .9% .7% .8% .8% .1% (2.3)% (.4)% Return (loss) on average shareholders' equity... 9.6 6.8 7.4 8.7 .4 (30.4) (7.2) Net interest margin............................. 6.3 7.4 7.1 7.0 8.7 7.0 7.0 Loans to deposits............................... 63.4 71.6 70.3 72.5 72.6 82.5 75.9 ASSET QUALITY RATIOS: (5) Nonperforming assets to total assets............ .1% .1% .2% .3% .7% 2.1% 3.8% Nonperforming loans to total loans.............. .1 .1 .2 .3 .8 2.4 5.3 Net loan charge-offs to average loans........... .1 .3 .4 .3 1.6 2.3 .5 Allowance for loan losses to total loans........ 1.1 1.0 1.1 1.3 1.7 1.8 1.8 Allowance for loan losses to nonperforming loans.......................................... 1,772.5 456.9 574.8 425.8 201.1 74.8 34.8 CAPITAL RATIOS: Tier I risk-based capital....................... 10.17% 10.97% 10.13% 11.37% 14.44% 13.2% 5.3% Total risk-based capital........................ 11.14 11.73 11.17 12.57 15.69 14.7 6.8 Leverage........................................ 6.4 8.5 5.6 10.0 11.9 10.9 4.6
- ------------------------------ (1) On September 28, 1995 the Company completed the acquisition of certain assets and the assumption of certain liabilities relating to the branch of Bank One, Texas, National Association Texas located in Waxahachie, Texas. (2) On May 31, 1994 the Company acquired 100% of the outstanding common stock of The Farmers Guaranty State Bank of Kennard, Kennard, Texas, and on December 8, 1994 the Company acquired 100% of the outstanding common stock of First National Bank, Whitesboro, Texas. (3) On March 23, 1993 the Company acquired 100% of the outstanding common stock of the Bank of East Texas, Chester, Texas and First State Bank, Wells, Texas. Operations of these two banks have been included in consolidated operations subsequent to February 28, 1993. (4) The information provided given for 1990, 1991 and 1992 has been restated to reflect a one for ten reverse stock split in June 1993. (5) All interim periods have been annualized. 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion highlights the major changes affecting the operations and financial condition of the Company for the nine months ended September 30, 1995 and 1994 and the three years ended December 31, 1994. The discussion should be read in conjunction with the consolidated financial statements and accompanying notes included elsewhere in this prospectus. GENERAL The Company derives substantially all of its revenues and income from the operation of its subsidiary, the Bank, which provides a full range of commercial and consumer banking services to businesses and individuals in the north and east Texas area and has attempted to distinguish itself by developing niche products such as insurance premium finance. As of September 30, 1995, the Company had total assets of $119.6 million, net loans of $67.9 million, total deposits of $108.2 million, and total shareholders' equity of $10.0 million. The Company reported net income of $648,413 for the nine months ended September 30, 1995 compared with net income of $293,734 for the nine months ended September 30, 1994 as a result of internal loan growth within its niche products and its acquisitions of community banks. During 1994, the Company had no effective tax rate through the utilization of its net operating losses. The Company returned to paying federal income taxes at the effective rate of 32% during 1995. Income before taxes was $948,990 for the nine months ended September 30, 1995, an increase of $647,756 or 215.0% when compared with the same period for 1994. On May 31, 1994, the Company acquired The Farmers Guaranty State Bank of Kennard, Texas. On December 8, 1994 the Company acquired the First National Bank, Whitesboro, Texas and on September 28, 1995, the Company acquired the assets and assumed the liabilities of the Waxahachie, Texas, branch of Bank One, Texas, National Association. The Company views these acquisitions as a means of expanding its operations and anticipates they will contribute favorably to future results of the Company. The Company continues to actively serve the banking needs of these local communities, as it has served the local communities of its other branches. The deposits at these new branches will allow the Company to increase its niche lending activities of IPF and insurance medical claims factoring. The Company's strategy is to continue to acquire community banks with low loan-to-deposit ratios and use excess deposits to fund IPF and other niche lending products. See "Business -- Acquisitions". RESULTS OF OPERATIONS NET EARNINGS Net earnings were $648,413 ($0.20 per share) for the nine months ended September 30, 1995, compared with net earnings of $293,734 ($0.13 per share) for the nine months ended September 30, 1994, an increase of $354,679 or 120.7%. Factors contributing to the increase in earnings in 1995 compared with 1994 include an increase in net interest income, loan growth in the Company's niche lending products, and the growth of noninterest income mainly as a result of the acquisition of The Farmers Guaranty State Bank, Kennard, Texas and the acquisition of First National Bank, Whitesboro, Texas. Net earnings were $472,760 for 1994 ($0.20 per share), compared with net earnings of $370,723 for 1993 ($0.19 per share) and $16,424 for 1992 ($0.00 per share). The earnings per share for 1994 were affected by additional shares issued in December 1994 in connection with the acquisition of First National Bank, Whitesboro. The 27.5% increase and 2,157.2% increase in earnings for 1994 and 1993 respectively, were attributable to an increase in net interest income resulting from improved asset quality, loan growth in the Company's niche lending products and acquisitions of community banks. EARNINGS BEFORE INCOME TAXES Earnings before income taxes were $948,990 for the nine months ended September 30, 1995, compared with $301,234 for the first nine months of 1994, a 215% increase. As previously mentioned, the Company 14 returned to paying federal income taxes at the effective rate of 32% during 1995, compared with a nominal effective tax rate for 1994. As a result of the return to paying federal taxes, the net income for the nine months ended September 30, 1995 may be more indicative of operating trends in the future. Conversely, earnings before income taxes in the 1995 period may be more useful when comparing results with prior periods. Earnings before income taxes were $490,448 in 1994, compared with $370,723 in 1993, an increase of $119,725 or 32.3%. Earnings before income taxes were $16,424 in 1992. The improvement in earnings before income taxes for 1994 compared with 1993 was primarily attributable to an increase in net interest income resulting from an increase in net interest margin. The increase in net interest income in 1994, as compared with 1993, was the result of loan growth within the Company's niche lending products. The average balance of insurance premium finance loans grew by 96.6% to a balance of $19.4 million from $9.9 million for 1994 and 1993, respectively. The 2,157.2% growth in earnings before income taxes in 1993 as compared with 1992 was attributable to an increase in net interest income as a result of loan growth. In 1993, the Company also realized a gain on the sale of investment securities of approximately $94,000. NET INTEREST INCOME Net interest income is the difference between income earned on interest-earning assets and the interest expense incurred on interest-bearing liabilities. The net yield on total interest-earning assets, also referred to as interest rate margin or net interest margin, represents net interest income divided by average interest-earning assets. The Company's principal interest-earning assets are loans, investment securities, medical receivables factoring and federal funds sold. Net interest income was $4.3 million for the first nine months of 1995, an increase of $1.6 million or 58.1% compared with the first nine months of 1994, resulting principally from an increase in interest-earning assets from $55.3 million to $107.9 million, a significant portion of which was comprised of loans (typically the highest yielding asset). The increase in interest-earning assets was offset by an increase in interest-bearing liabilities from $47.1 million to $94.7 million. In addition, the Company experienced a decrease in the net interest spread of 110 basis points from 6.9% to 5.8% for the nine months ended September 30, 1994 and 1995, respectively. The foregoing decrease resulted principally from the fact that the cost of interest-bearing liabilities increased more than the yield on interest-earning assets. The yield on interest-earning assets increased 10 basis points from 9.9% to 10.0%, while the cost of interest-bearing liabilities increased 120 basis points from 3.0% to 4.2% for the nine months ended September 30, 1994 and 1995, respectively. Net interest income was $3.9 million for 1994, an increase of $1.0 million or 35.8% compared with net interest income of $2.9 million for 1993, which represented an increase of $505,224 or 21.4% compared with net interest income of $2.4 million for 1992. The Company's average total interest-earning assets increased from approximately $41.2 million for 1993 to $54.8 million for 1994, representing a 33.1% increase resulting principally from an increase in loans. The net interest margin of 7.1% for 1994 increased 10 basis points from 7.0% for 1993. The Company's average total interest-earning assets increased from $27.1 million for 1992 to $41.2 million for 1993, representing a 51.7% increase resulting principally from an increase in loans and investment securities. The Company's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a "volume change". It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as a "rate change". The decline in the net yield on total interest-earning assets from 1994 through the first nine months of 1995 resulted principally from an increase in investment securities as a percentage of total interest-earning assets, which produced a lower average rate of return for the Company than loans, and the addition of the consumer, commercial and real estate loans through the acquisition of First National Bank, Whitesboro, Texas. The yield on consumer, commercial and real estate loans declined to 10.9% for the first nine months of 1995 from 12% for the twelve months ended December 31, 1994. The following table sets forth for each category of interest-earning assets and interest-bearing liabilities the average amounts outstanding, the interest earned or paid on such amounts and the average rate paid for the nine months 15 ended September 30, 1995 and 1994 and for the three years ended December 31, 1994, 1993 and 1992. The table also sets forth the average rate earned on all interest-earning assets, the average rate paid on all interest-bearing liabilities, and the net yield on average interest-earning assets for the same periods. AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME
NINE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, 1995 SEPTEMBER 30, 1994 --------------------------------- -------------------------------- INTEREST INTEREST AVERAGE INCOME/ AVERAGE AVERAGE INCOME/ AVERAGE A S S E T S BALANCE EXPENSE RATE BALANCE EXPENSE RATE ------------ ---------- ------- ----------- ---------- ------- Interest-earning assets: Interest-bearing deposits................................. $ 1,433,354 $ 76,419 7.1% $ 783,493 $ 40,389 6.9% U.S. Treasury and agency securities (1)................... 15,073,774 734,300 6.5 6,847,990 250,231 4.9 Federal funds sold........................................ 7,995,800 358,600 6.0 5,711,995 188,197 4.4 Loans (2)(3).............................................. 67,992,319 5,702,448 11.2 37,313,907 3,264,214 11.7 Allowance for loan losses................................. (711,919) N/A N/A (430,212) N/A N/A ------------ ---------- ------- ----------- ---------- ------- Total interest-earning assets........................... $ 91,783,328 $6,871,767 10.0% $50,227,173 $3,743,031 9.9% ------------ ---------- ------- ----------- ---------- ------- Cash and due from banks................................... 4,403,273 3,047,360 Premises and equipment.................................... 2,402,578 1,433,014 Accrued interest receivable............................... 639,556 167,977 Other real estate owned................................... 71,545 35,947 Other assets.............................................. 2,989,181 742,739 ------------ ----------- Total assets............................................ $102,289,461 $55,654,210 ------------ ----------- ------------ ----------- L I A B I L I T I E S Interest-bearing liabilities: Interest-bearing demand deposits.......................... $ 22,422,644 $ 476,084 2.8% $13,505,323 $ 231,110 2.3% Savings deposits.......................................... 4,697,675 93,699 2.7 3,844,726 74,622 2.6 Time deposits............................................. 52,078,213 1,855,244 4.8 25,399,059 665,832 3.5 Notes payable............................................. 1,297,565 111,915 11.5 -- -- -- ------------ ---------- ------- ----------- ---------- ------- Total interest-bearing liabilities...................... $ 80,496,097 $2,536,942 4.2% $42,749,108 $ 971,564 3.0% ------------ ---------- ------- ----------- ---------- ------- Noninterest-bearing deposits.............................. 12,297,624 6,912,272 Other liabilities......................................... 489,746 244,682 ------------ ----------- ------------ ----------- Total liabilities....................................... 93,283,467 49,906,062 Shareholders' equity........................................ 9,005,994 5,748,148 ------------ ----------- Total liabilities and equity............................ $102,289,461 $55,654,210 ------------ ----------- ------------ ----------- Net interest income......................................... $4,334,825 $2,771,467 ---------- ---------- ---------- ---------- Net interest spread......................................... 5.8% 6.9% ------- ------- ------- ------- Net interest margin......................................... 6.3% 7.4% ------- ------- ------- -------
- ------------------------ (1) Interest income on tax exempt securities does not reflect the tax equivalent yield. (2) Loans on nonaccrual status have been included in the computation of average balances. (3) The interest income on loans does not include loan fees. Loan fees are immaterial and are included in noninterest income. 16 AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME
YEARS ENDED DECEMBER 31, ---------------------------------------------------------------------------------------------- 1994 1993 1992 --------------------------------------- --------------------------------------- ------------ INTEREST INTEREST AVERAGE INCOME/ AVERAGE INCOME/ AVERAGE A S S E T S BALANCE EXPENSE AVERAGE RATE BALANCE EXPENSE AVERAGE RATE BALANCE - ------------------------------ ------------ ----------- ------------ ------------ ----------- ------------ ------------ Interest-earning assets: Interest-bearing deposits... $ 981,184 $ 68,173 6.9% $ 636,420 $ 20,853 3.3% $ 483,333 U.S. Treasury and agency securities (1)............. 7,648,411 362,078 4.7 9,567,829 507,273 5.3 -- Federal funds sold.......... 6,456,165 302,621 4.7 5,343,461 162,830 3.0 6,474,639 Loans (2)(3)................ 40,136,926 4,654,137 11.6 26,008,833 3,304,105 12.7 20,496,380 Allowance for loan losses... (444,805) N/A N/A (388,255) N/A N/A (311,970) ------------ ----------- --- ------------ ----------- --- ------------ Total interest-earning assets................. $ 54,777,881 5,387,009 9.8% 41,168,288 3,995,061 9.7% 27,142,382 ------------ ----------- --- ------------ ----------- --- ------------ ------------ ----------- --- ------------ ----------- --- ------------ Cash and due from banks..... 3,249,783 2,705,248 1,819,201 Premises and equipment...... 1,520,404 1,094,260 885,511 Accrued interest receivable................. 205,770 185,109 46,005 Other real estate owned..... 51,043 31,715 19,195 Other assets................ 1,357,765 417,878 640,993 ------------ ------------ ------------ Total assets............ $ 61,162,646 $ 45,602,49 $ 30,553,287 ------------ ------------ ------------ ------------ ------------ ------------ L I A B I L I T I E S Interest-bearing liabilities: Interest-bearing demand deposits................... $ 14,680,300 $ 259,113 1.8% 12,538,376 209,937 1.7% 6,935,234 Savings deposits............ 3,104,155 94,010 3.0 3,165,466 96,962 3.1 1,305,089 Time deposits............... 28,530,396 1,123,533 4.0 19,095,938 816,685 4.3 14,553,547 Notes payable............... 146,756 11,075 7.5 -- -- -- -- ------------ ----------- --- ------------ ----------- --- ------------ Total interest-bearing liabilities.............. $ 46,461,607 1,487,731 3.2 % 34,799,780 1,123,584 3.2 % 22,793,870 Noninterest-bearing deposits................... 7,996,860 6,375,876 3,675,287 Other liabilities........... 281,660 151,681 145,950 ------------ ------------ ------------ Total liabilities............. 54,740,127 41,327,337 26,615,107 Shareholders' equity.......... 6,422,519 4,275,161 3,938,180 ------------ ------------ ------------ Total liabilities and equity................... $ 61,162,646 $ 45,602,498 $ 30,553,287 ------------ ------------ ------------ ------------ ------------ ------------ Net interest income........... $ 3,899,278 $ 2,871,477 ----------- ----------- ----------- ----------- Net interest spread........... 6.6 % 6.5 % --- --- --- --- Net interest margin........... 7.1 % 7.0 % --- --- --- --- INTEREST INCOME/ A S S E T S EXPENSE AVERAGE RATE - ------------------------------ ----------- ------------ Interest-earning assets: Interest-bearing deposits... $ 17,455 3.6% U.S. Treasury and agency securities (1)............. -- -- Federal funds sold.......... 222,146 3.4 Loans (2)(3)................ 3,104,367 15.2 Allowance for loan losses... N/A N/A ----------- --- Total interest-earning assets................. 3,343,968 12.3% ----------- --- ----------- --- Cash and due from banks..... Premises and equipment...... Accrued interest receivable................. Other real estate owned..... Other assets................ Total assets............ L I A B I L I T I E S Interest-bearing liabilities: Interest-bearing demand deposits................... 194,073 2.8% Savings deposits............ 45,984 3.5 Time deposits............... 737,658 4.9 Notes payable............... -- -- ----------- --- Total interest-bearing liabilities.............. 977,715 4.3 % Noninterest-bearing deposits................... Other liabilities........... Total liabilities............. Shareholders' equity.......... Total liabilities and equity................... Net interest income........... $ 2,366,253 ----------- ----------- Net interest spread........... 8.0 % --- --- Net interest margin........... 8.7 % --- ---
- -------------------------- (1) Interest income on tax exempt securities does not reflect the tax equivalent yield. (2) Loans on nonaccrual status have been included in the computation of average balances. (3) The interest income on loans does not include loan fees. Loan fees are immaterial and are included in noninterest income. 17 The following table reflects the changes in net interest income stemming from changes in interest rates and from asset and liability volume, including mix. The change in interest attributable to both rate and volume has been allocated to the changes in the rate and the volume on a pro rata basis. RATE/VOLUME ANALYSIS OF NET INTEREST INCOME
YEARS ENDED DECEMBER 31, 1993 COMPARED WITH YEARS ENDED DECEMBER NINE MONTHS ENDED SEPTEMBER 30, DECEMBER 31, 1994 31, 1992 1995 COMPARED WITH NINE MONTHS COMPARED WITH --------- ENDED SEPTEMBER 30, 1994 DECEMBER 31, 1993 --------------------------------- --------------------------------- INCREASE (DECREASE) INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO DUE TO --------------------------------- --------------------------------- --------- VOLUME(1) RATE CHANGES VOLUME(1) RATE CHANGES VOLUME(1) --------- ----------- --------- --------- ----------- --------- --------- Interest Income: Interest-bearing deposits in financial institutions.......................... $ 34,062 $ 1,428 $ 36,030 $ (551) $ 47,871 $ 47,320 $ 5,133 U.S. Treasury and agency securities.... 378,968 105,101 484,069 (94,659) (50,536) (145,195) 507,273 Federal funds sold..................... 89,525 80,878 170,403 38,998 100,793 139,791 (36,164) Loans.................................. 2,578,263 (140,209) 2,438,234 1,659,906 (309,874) 1,350,032 750,748 --------- ----------- --------- --------- ----------- --------- --------- Total interest income.................... $3,081,358 $ 47,198 $3,128,736 $1,603,694 $(211,746) $1,391,948 $1,226,990 --------- ----------- --------- --------- ----------- --------- --------- Interest Expense: Interest-bearing demand deposits....... $ 179,906 $ 63,909 $ 243,815 $ 38,707 $ 10,469 $ 49,176 $ 114,730 Savings deposits....................... 16,962 2,115 19,077 (1,827) (1,125) (2,952) 57,705 Time deposits.......................... 885,864 304,707 1,190,571 375,946 (69,098) 306,848 206,265 Federal funds purchased and other borrowed funds........................ 111,915 -- 111,915 11,075 -- 11,075 -- --------- ----------- --------- --------- ----------- --------- --------- Total interest expense................... $1,194,647 $ 370,731 $1,565,378 $ 423,901 $ (59,754) $ 364,147 $ 78,700 --------- ----------- --------- --------- ----------- --------- --------- Net interest margin...................... $1,886,711 $(323,533) $1,563,358 $1,179,793 $(151,992) $1,027,801 $ 848,290 --------- ----------- --------- --------- ----------- --------- --------- --------- ----------- --------- --------- ----------- --------- --------- RATE CHANGES ----------- --------- Interest Income: Interest-bearing deposits in financial institutions.......................... $ (1,735) $ 3,398 U.S. Treasury and agency securities.... -- 507,273 Federal funds sold..................... (23,152) (59,316) Loans.................................. (551,010) 199,738 ----------- --------- Total interest income.................... $(575,897) $ 651,093 ----------- --------- Interest Expense: Interest-bearing demand deposits....... $ (98,866) $ 15,864 Savings deposits....................... (6,727) 50,978 Time deposits.......................... (127,238) 79,027 Federal funds purchased and other borrowed funds........................ -- -- ----------- --------- Total interest expense................... $(232,831) $ 145,869 ----------- --------- Net interest margin...................... $(343,066) $ 505,224 ----------- --------- ----------- ---------
- ------------------------------ (1) Non-accrual loans are included in the average volumes used in calculating this table. 18 PROVISION FOR LOAN LOSSES The amount of the provision for loan losses is based on periodic (not less than quarterly) evaluations of the loan portfolio, with particular attention directed toward nonperforming and other potential problem loans. During these evaluations, consideration is given to such factors as: management's evaluation of specific loans; the level and composition of nonperforming loans; historical loss experience; results of examinations by regulatory agencies; an internal asset review process; the market value of collateral; the strength and availability of guaranties; concentrations of credits; and other judgmental factors. The Company determines separate general allowances for IPF and non-IPF loans. The Company's loss experience on insurance premium finance lending was adversely affected during the second half of 1991 by the failure of a non-Best's rated insurance company. The Company has implemented certain changes in its lending policies and procedures with respect to insurance premium finance lending which have reduced the maximum concentration by insurance carrier except as approved by the Board of Directors and also reduced the amount of loans secured by unearned premiums of insurance policies written by non-rated carriers. See "Business -- Insurance Premium Financing". As a result of these changes in loan policy and recoveries of previously charged-off IPF loans, the Company's historical loss factor on IPF loans has improved from 0.15% in 1993 to 0.00% in 1994 and as of September 30, 1995. The Company recorded a $60,000 provision for loan losses during the nine months ended September 30, 1995 compared with $66,898 during the first nine months of 1994. As the Company's ratio of net charge-offs to average loans remained unchanged for these periods, the Company provided amounts to compensate for growth in the loan portfolio in order to maintain the allowance for loan losses at an adequate level. The 1994 provision for loan losses was $106,899 compared with $90,584 in 1993 and $299,555 in 1992. The 18% increase in the 1994 provision for loan losses when compared with 1993 is a result of the 54.3% growth in average loans outstanding. The 69.8% reduction in the provision for 1993 compared with 1992 was a result of successful collection efforts in both the insurance premium finance portfolio and the general loan portfolio. NONINTEREST INCOME Noninterest income is generated primarily from fees associated with noninterest and interest-bearing accounts as well as fees associated with loans (e.g., late fees). Noninterest income for the first nine months of 1995 was $1,056,095, an increase of $255,290 or 31.9% compared with noninterest income of $800,805 for the first nine months of 1994. The increase in noninterest income is attributed to the acquisition of the Farmers Guaranty State Bank, Kennard and First National Bank, Whitesboro during 1994, as well as an increase in loans outstanding. The acquisition of the two banks during 1994 increased the number and balance of loans outstanding and increased the number and balance of noninterest and interest-bearing accounts, which resulted in increased noninterest income. Noninterest income was $1,160,007 for 1994, a decrease of $20,801 or 1.8% compared with noninterest income of $1,181,808 for 1993, which represented an increase of $397,742 or 50.7% over 1992. While service charges and exchange fees increased from 1993 to 1994, loan fees and other income decreased. The decrease in loan fees was attributable to a decision by management to discontinue servicing outside loan portfolios. The decrease in other income from 1993 to 1994 is the result of a gain realized on the sale of investment securities during 1993 in the amount of approximately $94,000. Noninterest income increased from 1992 to 1993 in all categories, primarily as a result of the acquisition of banks in Wells and Chester, Texas. The following table sets forth the various categories of noninterest income for the nine months ended September 30, 1995 and 1994, and for the years ended December 31, 1994, 1993 and 1992. 19 NONINTEREST INCOME
NINE MONTHS ENDED SEPTEMBER 30, YEARS ENDED DECEMBER 31, ------------------------ -------------------------------------- 1995 1994 1994 1993 1992 ------------ ---------- ------------ ------------ ---------- Noninterest income Nonsufficient fund charges................... $ 214,501 $ 202,674 $ 263,315 $ 248,890 $ 145,365 Late fee charges............................. 366,356 293,582 426,476 304,354 278,520 Service charges.............................. 163,648 119,684 163,336 120,143 47,717 Collection fees.............................. 93,536 77,001 96,162 71,760 44,351 Credit life insurance........................ 59,570 33,231 44,402 49,777 46,346 Premium Finance servicing.................... -- -- -- 161,310 101,853 Secured credit card annual fee............... 4,487 13,774 15,905 36,968 52,837 Other........................................ 153,897 60,859 150,411 97,843 67,077 Gain on sale of investment................... 100 -- -- -- 90,763 ------------ ---------- ------------ ------------ ---------- Total noninterest income................... $ 1,056,095 $ 800,805 $ 1,160,007 $ 1,181,808 $ 784,066 ------------ ---------- ------------ ------------ ---------- ------------ ---------- ------------ ------------ ----------
NONINTEREST EXPENSE Noninterest expense was $4,381,930 for the first nine months of 1995, an increase of $1,177,790 or 36.8% compared with noninterest expense of $3,204,140 for the first nine months of 1994. This increase resulted principally from the acquisition of Farmers Guaranty State Bank, Kennard and First National Bank, Whitesboro during 1994. The addition of the two banks in 1994 resulted in additional personnel, occupancy and office expenses. The amortization of intangibles increased in 1995 as a result of the addition of goodwill and costs associated with the acquisition of Farmers Guaranty State Bank, Kennard in the amount of $296,164 and the addition of goodwill and costs associated with the acquisition of First National Bank, Whitesboro in the amount of $1,886,682. Deposits held by the Bank are insured by the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation ("FDIC"). The FDIC assessment is calculated on the level of deposits held by the Bank. The increase in the FDIC assessment in 1995 over 1994 was tied to the increased deposits added through the two acquisitions completed in 1994. The BIF assessment rate is determined by the FDIC for categories of banks based upon the risk to the insurance fund. On August 8, 1995, the FDIC's Board of Directors voted to significantly reduce the deposit insurance premiums paid by most banks but to keep existing assessment rates intact for savings associations. Under the new rate structure, the best-rated institutions insured by the BIF pay $.04 per $100 of domestic deposits, down from the rate of $.23 per $100. The new BIF assessment rates apply from the first day of the month after the BIF was recapitalized. The recapitalization of the BIF occurred in early September 1995. The FDIC has issued refunds to the best-rated institutions for assessments which exceeded the recapitalization of the BIF. The Bank received a refund from the FDIC of approximately $42,000. The change in assessment rate is expected to significantly reduce the cost of deposit insurance for the Bank. In connection with the new rate schedule, the FDIC established a process for quickly raising or lowering all rates for BIF-insured institutions up to twice a year without seeking public comment. See "Regulation and Supervision". Noninterest expense was $4,461,938 for 1994, an increase of $869,960 or 24.2% compared with noninterest expense of $3,591,978 for 1993, which represented an increase of $757,638 or 26.7% compared with noninterest expense of $2,834,340 for 1992. The increase in noninterest expense for 1994 from 1993 was attributable to a 28.3% increase in salaries and employee benefits and a 15.2% increase in general and administrative expenses. The increase in salaries and benefits for the same period was due primarily to additional staffing associated with the acquisition of the two banks and the Bank's loan and deposit growth. Noninterest expense increased in 1993 from 1992 primarily as a result of a 43.7% increase in salaries and employee benefits and a 12.4% increase in general and administrative expenses. The increase in salaries and benefits was due primarily to additional staffing associated with the two 1993 acquisitions, the Bank's loan and deposit growth and the establishment of the secured credit card program. 20 NONINTEREST EXPENSE
NINE MONTHS ENDED SEPTEMBER 30, YEARS ENDED DECEMBER 31, -------------------------- ---------------------------------------- 1995 1994 1994 1993 1992 ------------ ------------ ------------ ------------ ------------ Salaries and employee benefits............. $ 2,143,694 $ 1,577,591 $ 2,201,188 $ 1,715,952 $ 1,194,179 Occupancy and equipment.................... 668,483 473,588 669,936 495,055 411,587 General and administrative expense: Professional fees........................ 343,866 264,627 315,434 362,571 351,593 Office supplies.......................... 193,466 150,187 201,028 165,416 126,880 Travel and entertainment................. 49,760 47,603 60,162 62,184 42,593 Telephone................................ 115,428 95,616 128,407 103,921 78,384 Advertising.............................. 65,216 43,146 54,683 60,302 88,589 Postage.................................. 150,301 97,349 133,887 125,092 105,229 Amortization of intangibles.............. 137,171 34,329 51,201 35,567 29,388 Dues and subscriptions................... 28,322 36,704 54,609 26,707 20,935 Insurance................................ 97,200 78,420 97,473 59,882 25,519 Credit cards............................. 14,707 44,698 59,573 63,298 83,941 Bank service charge...................... 29,914 18,901 25,808 29,018 17,922 FDIC assessment.......................... 114,541 90,623 133,112 71,003 56,594 Credit reports........................... 40,911 15,025 17,714 48,495 27,256 Operational losses....................... -- -- -- -- 62,044 Other.................................... 188,950 135,733 257,723 167,515 111,707 ------------ ------------ ------------ ------------ ------------ Total general and administrative....... 1,569,753 1,152,961 1,590,814 1,380,971 1,228,574 ------------ ------------ ------------ ------------ ------------ Total noninterest expense.............. $ 4,381,930 $ 3,204,140 $ 4,461,938 $ 3,591,978 $ 2,834,340 ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
INCOME TAXES During 1993, the Company adopted STATEMENT OF FINANCIAL ACCOUNTING STANDARDS ("SFAS") No. 109, "Accounting for Income Taxes". The principal effect is to allow a tax benefit for cumulative book loss reserves in excess of tax reserves. SFAS No. 109 provides that deferred tax assets may be reduced by a valuation allowance if, based on the weight of available expense, it is more likely than not that some portion or all of the deferred tax asset will not be realized. In accordance with the provisions of SFAS No. 109, the Company elected not to restate prior years and has determined that the cumulative effect of implementation was not significant. The Company and the Bank will file a consolidated tax return for 1995. The Company estimates that its effective tax rate for 1995 will be approximately 32% and has recognized income tax expense of $300,577 on income before taxes of $948,990 for the nine months ended September 30, 1995 as compared with income tax expense of $7,500 on income before taxes of $301,234 for the nine months ended September 30, 1994. INTEREST RATE SENSITIVITY MANAGEMENT The operating income and net income of the Bank depend, to a substantial extent, on "rate differentials", i.e., the differences between the income the Bank receives from loans, securities and other earning assets, and the interest expense it pays to obtain deposits and other liabilities. These rates are highly sensitive to many factors which are beyond the control of the Bank, including general economic conditions and the policies of various governmental and regulatory authorities. See "Investment Considerations -- General Economic Conditions and Monetary Policy". The objective of monitoring and managing the interest rate risk position of the balance sheet is to contribute to earnings and to minimize the adverse changes in net interest income. The potential for earnings to be affected by changes in interest rates is inherent in a financial institution. Interest rate sensitivity is the relationship between changes in market interest rates and changes in net interest income due to the repricing characteristics of assets and liabilities. An asset sensitive position in a given period will 21 result in more assets being subject to repricing; therefore, as interest rates rise, such a position will have a positive effect on net interest income. Conversely, in a liability sensitive position, where liabilities reprice more quickly than assets in a given period, a rise in interest rates will have an adverse effect on net interest income. One way to analyze interest rate risk is to evaluate the balance of the interest rate sensitivity position. A mix of assets and liabilities that are roughly equal in volume and term and repricing represents a matched interest rate sensitivity position. Any excess of assets or liabilities in a particular period results in an interest rate sensitivity gap. The following table presents the interest rate sensitivity for the Company's interest-earning assets and interest-bearing liabilities at September 30, 1995: 22 INTEREST-RATE SENSITIVE ASSETS AND LIABILITIES
3 MONTHS 3 MONTHS TO 6 6 MONTHS 1 YEAR TO OVER 5 OR LESS MONTHS TO 1 YEAR 5 YEARS YEARS TOTAL ---------- ---------- ---------- ---------- ---------- ----------- Interest-earning assets: Interest-earning deposits in financial institutions.......... $ 90,179 $ 285,689 $ 284,768 $ 674,224 -- $ 1,334,860 Investment securities............ 2,244,856 1,029,188 138,479 6,108,666 $7,496,069 17,017,258 Federal funds sold............... 21,660,000 -- -- -- -- 21,660,000 Loans............................ 26,278,756 13,691,539 12,558,560 13,985,289 1,409,399 67,923,543 ---------- ---------- ---------- ---------- ---------- ----------- Interest-earning assets............ $50,273,791 $15,006,416 $12,981,807 $20,768,179 $8,905,468 $107,935,661 ---------- ---------- ---------- ---------- ---------- ----------- Interest-bearing liabilities: Interest-bearing demand deposits........................ $25,892,195 -- -- -- -- $25,892,195 Savings deposits................. 5,529,137 -- -- -- -- 5,529,137 Time deposits.................... 16,234,083 $13,811,978 $21,682,568 $11,144,246 -- 62,872,875 Notes payable.................... -- 375,000 -- -- -- 375,000 ---------- ---------- ---------- ---------- ---------- ----------- Interest-bearing liabilities....... $47,655,415 $14,186,978 $21,682,568 $11,144,246 -- $94,669,207 ---------- ---------- ---------- ---------- ---------- ----------- Period interest sensitivity gap.... $2,618,376 $ 819,438 $(8,700,761) $9,623,933 $8,905,468 $13,266,454 ---------- ---------- ---------- ---------- ---------- ----------- ---------- ---------- ---------- ---------- ---------- ----------- Cumulative interest sensitivity gap............................... $2,618,376 $3,437,814 $(5,262,947) $4,360,986 $13,266,454 $13,266,454 ---------- ---------- ---------- ---------- ---------- ----------- ---------- ---------- ---------- ---------- ---------- ----------- Cumulative gap as a percent of total assets...................... 2.2% 2.9% (4.4%) 3.6% 11.1% 11.1% Cumulative interest-sensitive assets as percent of cumulative interest-sensitive liabilities.... 105.5% 105.6% 93.7% 104.6% 114.0% 114.0%
The cumulative rate-sensitive gap position at one year was a liability-sensitive position of $5.3 million, or negative 4.4%, which indicates that the Company is currently in a closely matched interest rate-sensitive position. Accordingly the Company believes it will not experience a significant impact from changes in interest rates. The Company undertakes this interest rate-sensitivity analysis to monitor the potential risk to future earnings from the impact of possible future changes in interest rates on currently existing net assets or net liability positions. However, this type of analysis is as of a point-in-time, when in fact the company's interest rate sensitivity can quickly change as market conditions, customer needs, and management strategies change. Thus, interest rate changes do not affect all categories of assets and liabilities equally or at the same time. The Company's investment policy does not permit the purchase of derivative financial instruments or structured notes. The preceding table does not necessarily indicate the impact of general interest rate movements on the Company's net interest income because the repricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures. Currently, the Bank is holding approximately $812,000 in mortgage-backed securities. Although the mortgage-backed securities have a stated maturity greater than five years, it is not uncommon for mortgage-backed securities to fully pay down well ahead of stated maturities. As a result, assets and liabilities indicated as repricing within the same period may, in fact, reprice at different times and at different rate levels. 23 ANALYSIS OF FINANCIAL CONDITION LOANS AND ASSET QUALITY The Company's loans are diversified by borrower and industry group. Loan growth has occurred every year over the past five years and can be attributed to acquisitions, increased loan demand and the addition of new lending products. The following table describes the composition of loans by major categories outstanding at September 30, 1995 and at December 31, 1994, 1993, 1992, 1991 and 1990: LOAN PORTFOLIO ANALYSIS
DECEMBER 31, SEPTEMBER 30, ---------------------------------------------------------- 1995 1994 1993 1992 1991 1990 ------------- ---------- ---------- ---------- ---------- ---------- AGGREGATE PRINCIPAL AMOUNT ------------------------------------------------------------------------- Loans, net of unearned interest: Insurance premium financing..... $23,723,803 $20,496,562 $14,209,177 $7,051,266 $8,015,723 $6,801,483 Commercial loans................ 15,590,320 13,205,698 5,198,223 4,142,926 4,029,111 2,609,485 Installment loans............... 10,139,550 10,968,948 7,961,350 6,395,752 5,558,513 4,679,965 Real estate loans............... 16,224,602 17,297,636 1,878,030 809,215 738,950 668,664 Medical claims receivable....... 2,969,812 2,694,506 2,379,482 1,094,461 915,259 429,412 ------------- ---------- ---------- ---------- ---------- ---------- Total loans..................... 68,648,087 64,663,350 31,626,262 19,493,620 19,257,556 15,189,009 Less: Allowance for loan losses......................... (724,544) (697,948) (401,227) (324,728) (343,206) (276,473) ------------- ---------- ---------- ---------- ---------- ---------- Total net loans............... $67,923,543 $63,965,402 $31,225,035 $19,168,892 $18,914,350 $14,912,536 ------------- ---------- ---------- ---------- ---------- ---------- ------------- ---------- ---------- ---------- ---------- ---------- PERCENTAGE OF LOAN PORTFOLIO ------------------------------------------------------------------------- Loans, net of unearned interest: Insurance premium financing..... 34.6% 31.7% 44.9% 36.1% 41.6% 44.8% Commercial loans................ 22.7 20.4 16.5 21.2 20.9 17.1 Installment loans............... 14.8 17.0 25.2 32.9 28.9 30.9 Real estate loans............... 23.6 26.8 5.9 4.2 3.8 4.4 Medical claims receivable....... 4.3 4.1 7.5 5.6 4.8 2.8 ------------- ---------- ---------- ---------- ---------- ---------- Total......................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% ------------- ---------- ---------- ---------- ---------- ---------- ------------- ---------- ---------- ---------- ---------- ----------
The concentration of IPF loans may expose the Bank to greater risk of loss than would a more diversified loan portfolio. See "Investment Considerations -- Insurance Premium Financing Concentration". As of September 30, 1995 and December 31, 1994 commitments of the Bank under standby letters of credit and unused lines of credit totaled approximately $2,448,000 and $2,353,000, respectively. Stated loan maturities (including floating rate loans reset to market interest rates) of the total loan portfolio, net of unearned income, as of September 30, 1995 were: STATED LOAN MATURITIES
WITHIN ONE ONE YEAR TO AFTER FIVE YEAR FIVE YEARS YEARS TOTAL ------------- ------------- ------------ ------------- Stated Loan Maturities/Floating Rates Reset: Insurance premium financing......................... $ 23,723,803 $ -- $ -- $ 23,723,803 Commercial & real estate loans...................... 25,600,032 4,805,491 1,409,399 31,814,922 Installment loans................................... 959,752 9,179,798 -- 10,139,550 Medical claims receivable........................... 2,969,812 -- -- 2,969,812 ------------- ------------- ------------ ------------- Total............................................. $ 53,253,399 $ 13,985,289 $ 1,409,399 $ 68,648,087 ------------- ------------- ------------ ------------- ------------- ------------- ------------ -------------
24 Rate sensitivities of the total loan portfolio before unearned income, as of September 30, 1995 were as follows: LOAN REPRICING
WITHIN ONE ONE YEAR TO AFTER FIVE YEAR FIVE YEARS YEARS TOTAL ------------- ------------- ------------ ------------- Fixed rate............................................ $ 35,264,000 $ 13,728,000 $ 1,409,000 $ 50,401,000 Variable rate......................................... 20,027,000 183,000 -- 20,210,000 Nonaccrual............................................ -- 27,000 -- 27,000 ------------- ------------- ------------ ------------- Total............................................... $ 55,291,000 $ 13,938,000 $ 1,409,000 $ 70,638,000 ------------- ------------- ------------ ------------- ------------- ------------- ------------ -------------
The maturities presented above are based upon contractual maturities. Many of these loans are made on a short-term basis with the possibility of renewal at time of maturity. All loans, however, are reviewed on a continuous basis for creditworthiness. NONPERFORMING ASSETS The Company's financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on its loan portfolio, unless a loan is placed on a nonaccrual basis. Loans are placed on a nonaccrual basis when there are serious doubts regarding the complete collectibility of principal and interest. Amounts received on nonaccrual loans generally are applied first to principal and then to interest after all principal has been collected. Troubled debt restructurings are those for which concessions, including reduction of interest rates or deferral of interest or principal, have been granted, due to a borrower's weakened financial condition. Interest on restructured loans is accrued at the restructured rates when it is anticipated that no loss of original principal will occur. It is the policy of the Bank not to renegotiate the terms of a loan simply because of a delinquent status. Rather, a loan is generally transferred to a nonaccrual status if it is not in the process of collection and is delinquent in payment of either principal or interest beyond 90 days. Loans which are 90 days delinquent but are well secured and in the process of collection are not included in nonperforming assets. Other nonperforming assets consist of real estate acquired through loan foreclosures or other workout situations and other assets acquired through repossessions. The following table summarizes nonperforming assets by category as of September 30, 1995 and December 31, 1994: NONPERFORMING ASSETS
SEPTEMBER 30, DECEMBER 31, 1995 1994 ------------- ------------ Nonaccrual loans.................................................................... $ 27,000 $ 83,000 Loans 90 days past due and still accruing interest.................................. 13,877 38,432 ------------- ------------ Total nonperforming loans........................................................... 40,877 121,432 Other real estate owned and other assets............................................ 92,830 121,359 ------------- ------------ Total nonperforming assets.......................................................... $ 133,707 $ 242,791 ------------- ------------ ------------- ------------ Nonperforming assets to total assets................................................ 0.01% 0.02% Nonperforming loans to total loans.................................................. 0.01% 0.02%
The classification of a loan on nonaccrual status does not necessarily indicate that the principal is uncollectible, in whole or in part. A determination as to collectibility is made by the Bank on a case-by-case basis. The Bank considers both the adequacy of the collateral and the other resources of the borrower in determining the steps to be taken to collect nonaccrual loans. The final determination as to these steps is made on a case-by-case basis. Alternatives that are considered are foreclosure, collecting on guarantees, restructuring the loan or collection lawsuits. 25 The following table sets forth a summary of other real estate owned and other collateral acquired as of September 30, 1995: OTHER REAL ESTATE OWNED & OTHER COLLATERAL ACQUIRED
NUMBER OF NET BOOK DESCRIPTION PARCELS/AUTOS CARRYING VALUE - ------------------------------------------------------------ ------------- -------------- Developed property.......................................... 2 $29,676 Vacant land or unsold lots.................................. 2 3,429 Repossessed automobiles..................................... 15 59,725 --- ------- 19 $92,830 --- ------- --- -------
ALLOWANCE FOR LOAN LOSSES In originating loans, the Company recognizes that credit losses will be experienced and the risk of loss will vary with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the quality of the collateral for such loan. The allowance for loan losses represents the Company's estimate of the allowance necessary to provide for losses incurred in the loan portfolio. In making this determination, the Company analyzes the ultimate collectibility of the Company's loan portfolio, incorporating feedback provided by the internal loan review staff and provided by examinations performed by regulatory agencies. The Company makes an ongoing evaluation as to the adequacy of the allowance for loan losses. To establish the appropriate level of the allowance, all loans (including nonperforming loans), commitments to extend credit and standby letters of credit are reviewed and classified as to potential loss exposure. Specific allowances are then established for those loans, commitments to extend credit or standby letters of credit with identified loss exposure and an additional allowance is maintained based upon the size, quality, and concentration characteristics of the remaining loan portfolio using both historical quantitative trends and the Company's evaluation of qualitative factors including future economic and industry outlooks. The determination by the Company of the appropriate level of allowance amount was $724,544 at September 30, 1995. The allowance for loan losses is based on estimates, and ultimate losses will vary from current estimates. These estimates are reviewed monthly and as adjustments, either positive or negative, become necessary they are reported in earnings in the periods in which they become known. The following table presents a detailed analysis of the Company's allowance for loan losses for the nine months ended September 30, 1995 and for the years ended December 31, 1994, 1993, 1992, 1991 and 1990: 26 ALLOWANCE FOR LOAN LOSSES
DECEMBER 31, SEPTEMBER 30, ---------------------------------------------------------- 1995 1994 1993 1992 1991 1990 ------------- ---------- ---------- ---------- ---------- ---------- Beginning balance................. $ 697,948 $ 401,227 $ 324,728 $ 343,206 $ 276,473 $ 108,513 ------------- ---------- ---------- ---------- ---------- ---------- Charge-offs: Commercial loans................ (6,000) (41,537) (48,681) (202,777) (71,000) (52,658) Installment loans............... (76,750) (163,669) (179,713) (287,113) (179,140) (17,189) Real estate loans............... -- (5,350) -- -- -- -- Insurance premium finance....... -- (1,710) (19,380) (182,423) (231,000) -- ------------- ---------- ---------- ---------- ---------- ---------- Total charge-offs................. (82,750) (212,266) (247,774) (672,313) (481,140) (69,847) ------------- ---------- ---------- ---------- ---------- ---------- Recoveries: Commercial loans................ 6,009 15,698 1,412 30,081 4,000 1,000 Installment loans............... 24,031 43,070 88,511 89,005 50,000 14,807 Real estate loans............... 9,125 -- -- -- 15,373 1,000 Insurance premium finance....... -- 2,488 71,790 235,194 12,000 -- ------------- ---------- ---------- ---------- ---------- ---------- Total recoveries.................. 39,165 61,256 161,713 354,280 81,373 16,807 ------------- ---------- ---------- ---------- ---------- ---------- Net charge-offs................... (43,585) (151,010) (86,061) (318,033) (399,767) (53,040) Bank acquisition.................. 10,181 340,832 71,976 -- -- 0 Provision for loan losses......... 60,000 106,899 90,584 299,555 466,500 221,000 ------------- ---------- ---------- ---------- ---------- ---------- Ending balance.................... $ 724,544 $ 697,948 $ 401,227 $ 324,728 $ 343,206 $ 276,473 ------------- ---------- ---------- ---------- ---------- ---------- ------------- ---------- ---------- ---------- ---------- ---------- Period end total loans, net of unearned interest................ $68,648,087 $64,663,350 $31,626,262 $19,493,620 $19,199,387 $15,142,843 ------------- ---------- ---------- ---------- ---------- ---------- ------------- ---------- ---------- ---------- ---------- ---------- Average loans..................... $67,992,319 $40,136,926 $26,008,833 $20,496,380 $17,496,528 $11,303,522 ------------- ---------- ---------- ---------- ---------- ---------- ------------- ---------- ---------- ---------- ---------- ---------- Ratio of net charge-offs to average loans.................... 0.1% 0.4% 0.3% 1.6% 2.3% 0.5% ------------- ---------- ---------- ---------- ---------- ---------- ------------- ---------- ---------- ---------- ---------- ---------- Ratio of provision for loan losses to average loans................. 0.1% 0.3% 0.4% 1.5% 2.7% 2.0% ------------- ---------- ---------- ---------- ---------- ---------- ------------- ---------- ---------- ---------- ---------- ---------- Ratio of allowance for loan losses to ending total loans............ 1.1% 1.1% 1.3% 1.7% 1.8% 1.8% ------------- ---------- ---------- ---------- ---------- ---------- ------------- ---------- ---------- ---------- ---------- ---------- Ratio of allowance for loan losses to total nonperforming loans..... 1,772.5% 574.8% 425.8% 201.1% 74.8% 34.8% ------------- ---------- ---------- ---------- ---------- ---------- ------------- ---------- ---------- ---------- ---------- ---------- Ratio of allowance for loan losses to total nonperforming assets.... 541.9% 287.5% 311.2% 148.5% 60.5% 32.9% ------------- ---------- ---------- ---------- ---------- ---------- ------------- ---------- ---------- ---------- ---------- ----------
27 The following table sets forth an allocation of the allowance for loan losses among categories as of September 30, 1995 and December 31, 1994. The Company believes that any allocation of the allowance for loan losses into categories lends an appearance of precision which does not exist. The allowance is utilized as a single unallocated allowance available for all loans. The following allocation table should not be interpreted as an indication of the specific amounts or the relative proportion of future charges to the allowance. Such a table is merely a convenient device for assessing the adequacy of the allowance as a whole. The following allocation table has been derived by applying a general allowance to the portfolio as a whole, in addition to specific allowance amounts for internally classified loans. In retrospect, the specific allocation in any particular category may prove excessive or inadequate and consequently may be reallocated in the future to reflect the then current condition. Accordingly, the entire allowance is available to absorb losses in any category. ALLOWANCE FOR LOAN LOSSES
SEPTEMBER 30, 1995 DECEMBER 31, 1994 ------------------------------ ------------------------------ PERCENT OF ALLOWANCE PERCENT OF ALLOWANCE BY CATEGORY TO BY CATEGORY TO LOANS, NET OF LOANS, NET OF AMOUNT UNEARNED INCOME AMOUNT UNEARNED INCOME -------- -------------------- -------- -------------------- Insurance premium financing loans................................. $159,162 .23% $136,326 .21% Commercial loans.................................................. 184,606 .27% 181,669 .28% Installment loans................................................. 229,387 .33% 224,697 .35% Real estate loans................................................. 151,389 .22% 155,256 .24% -------- --- -------- --- Total........................................................... $724,544 1.1% $697,948 1.1% -------- --- -------- --- -------- --- -------- ---
INVESTMENT ACTIVITIES The investment portfolio, which was 15.8% of the Company's earning asset base as of September 30, 1995, is being managed to minimize interest rate risk, maintain sufficient liquidity and maximize return. Investment securities which are classified as held-to-maturity are purchased with the intent and ability of the Company to hold them to maturity as evidenced by the strong capital position of the Company and short maturity of the portfolio. Securities classified as held-to-maturity are carried at historical cost. The Company's financial planning anticipates income streams based on normal maturity and reinvestment. The short duration of the portfolio provides adequate liquidity through normal maturities. Investment securities classified as available-for-sale are purchased with the intent to provide liquidity and to increase returns. The securities classified as available-for-sale are carried at fair value. The Company does not have any securities classified as trading. As of September 30, 1995, $10.3 million in investment securities were classified as held-to-maturity and $6.5 million were classified as available-for-sale. On December 8, 1994, the Bank's investment portfolio increased by $14.6 million as a result of the acquisition of the bank in Whitesboro. The securities added to the investment portfolio through the acquisition increased the size of the investment portfolio by approximately 213%. This large increase resulted in a need to restructure the investment portfolio in an effort to address capital budgeting needs and to address the Bank's investment objectives. During the first quarter of 1995, $4.7 million in available-for-sale securities were sold for gross realized gains of $100 and no gross recognized losses. As of September 30, 1995, proceeds from the maturity of held-to-maturity securities were $2.7 million and the maturity of available-for-sale securities were $2.7 million. Purchases of held-to-maturity securities were $3.5 million and purchases of available-for-sale securities were $4.0 million. Prior to the acquisition of the bank in Whitesboro, all investment securities were classified as held-to-maturity with the exception of the Federal Reserve Bank stock which was classified as available-for-sale. During 1994, the Bank's investment portfolio increased by $14.6 million as a result of the acquisition of the bank in Whitesboro. At the time of acquisition, $4.7 million was classified as held-to-maturity and $9.8 million was classified as available-for-sale. As of December 31, 1994, the net unrealized loss on the available- 28 for-sale securities was $4,301. Proceeds from sales of held-to-maturity investment securities during the twelve months ended December 31, 1994 were $500,000. These securities were sold within 90 days of the call date and were expected to be called. The amortized cost of the held-to-maturity securities was $9.5 million as compared with their estimated market value of $9.4 million on December 31, 1994. The unrealized loss on the held-to-maturity securities was $189,970 and has not been realized because the Company has the intent and the ability to hold these securities to maturity. The securities within the available-for-sale classification had an amortized cost of $10.0 million and an estimated market value of $10.0 million on December 31, 1994. The unrealized loss in the available-for-sale securities was $4,301 as of December 31, 1994. These unrealized losses are the result of interest rate movements during 1994 and other market forces, and would be realized in part or in whole if some or all of the available-for-sale securities were sold and no changes in the respective market values occurred. The mortgage-backed securities held by the Bank include $511,554 fixed rate and no variable rate as held-to-maturity. The held-to-maturity mortgage-backed securities are stated at cost, adjusted for amortization of premiums and accretion of fees and discounts using a method that approximates a level yield. The available-for-sale mortgage-backed securities includes $147,976 fixed rate mortgage-backed securities and no variable rate mortgage-backed securities. The available-for-sale securities are carried at fair value. The following tables describe the composition of investments by major category and maturity at September 30, 1995: INVESTMENT PORTFOLIO
HELD-TO- AVAILABLE- MATURITY FOR-SALE ------------- ------------ U.S. Treasury notes.................................................................. $ 99,205 $ 495,000 U.S. Government agencies............................................................. 5,476,904 5,909,800 State and County Municipal securities................................................ 4,735,574 -- Federal Reserve Bank stock........................................................... -- 280,850 Other investments.................................................................... -- 19,925 ------------- ------------ Total.............................................................................. $ 10,311,683 $ 6,705,575 ------------- ------------ ------------- ------------
29 INVESTMENT PORTFOLIO MATURITY/REPRICING SCHEDULE
MATURING OR REPRICING ------------------------------------------------------------------------------------------- AFTER 1 YEAR BUT WITHIN 5 AFTER 5 YEARS BUT WITHIN OTHER WITHIN 1 YEAR YEARS 10 YEARS SECURITIES ------------------------- ------------------------- ------------------------- ---------- AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT ------------ ----- ------------ ----- ------------ ----- ---------- HELD-TO-MATURITY - ------------------------------ U.S. Treasury notes........... $ 99,205 6.4% -- -- -- -- -- U.S. Government agencies...... 790,286 5.6% $ 2,508,963 5.8% $ 1,666,101 6.9% -- Municipals.................... 342,602 4.3% 2,576,414 4.1% 1,816,558 4.1% -- Mortgage-backed securities.... -- -- -- -- 511,554 5.9% -- ------------ ------------ Total....................... $ 1,232,093 -- $ 5,085,377 -- $ 3,994,213 -- -- ------------ ------------ ------------ ------------ AVAILABLE-FOR-SALE - ------------------------------ U.S. Treasury notes........... $ 197,994 6.8% 297,006 7.3% U.S. Government agencies...... 203,709 6.6% 2,339,534 6.7% 3,218,581 7.6% Mortgage-backed securities.... -- -- -- $ 147,976 Federal Reserve Bank stock.... -- -- -- 280,850 Other investments............. -- -- -- 19,925 ------------ ------------ ---------- Total....................... $ 401,703 $ 2,636,540 $ 3,218,581 $ 448,751 ------------ ------------ ------------ ---------- ------------ ------------ ------------ ---------- YIELD ----- HELD-TO-MATURITY - ------------------------------ U.S. Treasury notes........... -- U.S. Government agencies...... -- Municipals.................... -- Mortgage-backed securities.... -- Total....................... -- AVAILABLE-FOR-SALE - ------------------------------ U.S. Treasury notes........... U.S. Government agencies...... Mortgage-backed securities.... 6.3% Federal Reserve Bank stock.... Other investments............. Total.......................
DEPOSIT ACTIVITIES Deposits are attracted through the offering of a broad variety of deposit instruments, including checking accounts, money market accounts, regular savings accounts, term certificate accounts (including "jumbo" certificates in denominations of $100,000 or more), and retirement savings plans. The Company's average balance of total deposits was $91,496,156 for the nine months ended September 30, 1995, representing an increase of $37,184,445 or 68.5% compared with the average balance of total deposits for the year ended December 31, 1994. The Company's average balance of total deposits was $54,311,711 for the year ended 1994, an increase of $13,136,055 or 31.9% compared with the average balance of total deposits outstanding for 1993 of $41,175,656, an increase of $14,706,499 or 55.6% compared with the average balance of total deposits outstanding for 1992 of $26,469,157. The increases in deposits are due to both acquisitions and internally generated growth. The following table sets forth certain information regarding the Bank's average deposits as of September 30, 1995 and December 31, 1994: AVERAGE DEPOSITS
SEPTEMBER 30, 1995 DECEMBER 31, 1994 ------------------------------------------- ------------------------------------------- AVERAGE PERCENT OF AVERAGE RATE AVERAGE PERCENT OF AVERAGE RATE AMOUNT TOTAL PAID AMOUNT TOTAL PAID ------------- ----------- --------------- ------------- ----------- --------------- Noninterest-bearing demand deposits...................... $ 12,297,624 13.4% N/A $ 7,996,860 14.7% N/A Interest-bearing demand deposits...................... 22,422,644 24.5% 2.8% 14,680,300 27.0% 1.8% Savings deposits............... 4,697,675 5.2% 2.7% 3,104,155 5.7% 2.5% Time deposits.................. 52,078,213 56.9% 4.8% 28,530,396 52.6% 4.0% ------------- ----- --- ------------- ----- --- Total average deposits....... $ 91,496,156 100.0% 4.2% $ 54,311,711 100.0% 3.2% ------------- ----- --- ------------- ----- --- ------------- ----- --- ------------- ----- ---
30 As of September 30, 1995, non-brokered time deposits over $100,000 represented 12.8% of total deposits, compared with 8.6% of total deposits as of December 31, 1994, 12.9% as of December 31, 1993, and 16.2% as of December 31, 1992. As of September 30, 1995, jumbo certificates of deposits in excess of $100,000 accounted for $13,885,925 of the Bank's deposits. Of this amount, $12,243,610 had a maturity of one year or less. The Bank does not have and does not solicit brokered deposits. The following table sets forth the remaining maturities for time deposits of $100,000 or more at September 30, 1995 and at December 31, 1994: TIME DEPOSITS OF $100,000 OR MORE
SEPTEMBER 30, DECEMBER 31, MATURITY RANGE 1995 1994 - ---------------------------------------------------------------- ------------- ------------ Three months or less............................................ $ 5,459,318 $3,054,111 Three through six months........................................ 2,165,640 1,562,924 Six through twelve months....................................... 4,618,652 3,125,847 Over twelve months.............................................. 1,642,315 200,000 ------------- ------------ Total......................................................... $ 13,885,925 $7,942,882 ------------- ------------ ------------- ------------
RETURN ON EQUITY AND ASSETS The following are various ratios for the Company for the nine months ended September 30, 1995 and the year ended December 31, 1994: RETURN ON EQUITY AND ASSETS
FOR THE NINE MONTHS ENDED FOR THE YEAR SEPTEMBER 30, ENDED DECEMBER 1995 31, 1994 ----------------- --------------- Return on average assets........................................ 0.9% 0.8% Return on average equity........................................ 9.6% 7.4% Average equity to average assets................................ 8.8% 10.5%
LIQUIDITY The Bank's investment securities portfolio, including federal funds sold, and its cash and due from bank deposit balances serve as the primary sources of liquidity. At September 30, 1995, 12.8% of the Bank's interest-bearing liabilities were in the form of time deposits of $100,000 and over. Substantially all of such large deposits were obtained from the Bank's market area, and none were obtained through brokers. Management believes these deposits to be a stable source of funds. However, if a large number of these time deposits matured at approximately the same time and were not renewed, the Bank's liquidity could be adversely affected. Currently, the maturities of the Bank's large time deposits are spread throughout the year, with 40% maturing in the fourth quarter of 1995, 16% maturing in the first quarter of 1996, 33% maturing in the second and third quarter of 1996, and the remaining 11% maturing thereafter. The Bank monitors those maturities in an effort to minimize any adverse effect on liquidity. The Bank is limited through regulatory commitments from using brokered funds without prior approval. The Company raised $1.3 million during 1995, $2.3 million during 1994, $852,000 during 1993, and $779,000 during 1992 through the sale, in registered offerings, private offerings and incentive stock option exercises, of the Company's Common Stock. Management anticipates that future registered and private offerings of the Company's Common Stock may be used to raise additional capital, in connection with acquisitions or if the regulatory capital requirements with which the Bank must comply necessitate the injection of additional capital by the Company into the Bank. Failure to raise such additional capital could adversely impact the growth of the Bank or result in its failure to comply with applicable regulatory capital 31 requirements, which could necessitate a reduction in the volume of assets and deposits of the Bank. Such reductions could adversely affect the Bank's earnings and liquidity. See "Regulation and Supervision -- Capital Adequacy Guidelines". In the longer term, the liquidity of the Company and its ability to meet its cash obligations will depend substantially on its receipt of dividends from the Bank, which are limited by banking statutes and regulations. See "Regulation and Supervision". CAPITAL RESOURCES The Company's shareholders' equity at September 30, 1995 was $10.0 million, compared with $8.1 million at December 31, 1994. The growth in equity has been the result of the sale of Common Stock by the Company and the retention of earnings. The Company had consolidated income of $648,413 for the nine months ended September 30, 1995. There can be no assurance that the Company can continue to operate profitably in the future and failure to operate profitably would have a material adverse effect on the Company. The Bank is expected to meet a minimum risk-based capital ratio to risk-weighted assets ratio of 8%, of which at least one-half (or 4%) must be in the form of Tier 1 (core) capital. The remaining one-half (or 4%) may be either in the form of Tier 1 (core) or Tier 2 (supplementary) capital. The amount of loan loss allowance that may be included in capital is limited to 1.25% of risk-weighted assets. The ratio of Tier 1 (core) and the combined amount of Tier 1 (core) and Tier 2 (supplementary) capital to risk-weighted assets for the Bank were 10.17% and 11.14%, respectively, at September 30, 1995, and 10.13% and 11.17%, respectively, at December 31, 1994. The Bank is currently, and expects to continue to be, in compliance with these guidelines. See "Regulation and Supervision -- Capital Adequacy Guidelines". While the Company believes it has sufficient financing for its working capital needs until the end of its 1995 fiscal year, the Company is considering acquiring banks in addition to the Midlothian Bank, the branch acquired in 1995 and the four banks acquired in 1993 and 1994. There can be no assurance that the Company's present capital and financing will be sufficient to finance future operations thereafter. If the Company sells additional shares of Common Stock to raise funds, the terms and conditions of the issuances and any dilutive effect may have an adverse impact on the existing shareholders. If additional financing becomes necessary, there can be no assurance that such financing can be obtained on satisfactory terms. In this event, the Company could be required to restrict its operations. See "Investment Considerations -- Additional Financing". The Board of Governors of the Federal Reserve System ("FRB") has announced a policy sometimes known as the "source of strength doctrine" that requires a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. The FRB has interpreted this requirement to require that a bank holding company, such as the Company, stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity. The FRB has stated that it would generally view a failure to assist a troubled or failing subsidiary bank in these circumstances as an unsound or unsafe banking practice or a violation of Regulation Y or both, justifying a cease and desist order or other enforcement action, particularly if appropriate resources are available to the bank holding company on a reasonable basis. The requirement that a bank holding company, such as the Company, make its assets and resources available to a failing subsidiary bank could have an adverse effect upon the Company and its shareholders. The following table sets forth an analysis of the Bank's capital ratios: 32 RISK-BASED CAPITAL RATIOS
SEPTEMBER 30, DECEMBER 31, MINIMUM WELL- ------------- ------------------------------------------- CAPITAL CAPITALIZED 1995 1994 1993 1992 RATIOS RATIOS ------------- ------------- ------------- ------------- ----------- ----------- Tier I risk-based capital... $ 7,596,000 $ 6,790,000 $ 3,821,000 $ 2,978,000 Tier II risk-based capital.. 725,000 698,000 401,000 258,000 Total capital............... 8,321,000 7,488,000 4,222,000 3,236,000 Risk-weighted assets........ 74,692,000 67,011,000 33,594,000 20,622,000 Capital ratios (1): Tier I risk-based capital.................. 10.17% 10.13% 11.37% 14.44% 4.00% 6.00% Tier II risk-based capital.................. 11.14 11.17 12.57 15.69 8.00 10.00 Leverage ratio............ 6.41 5.56 9.96 11.92 4.00 5.00 Pro Forma Capital Ratios (2): Tier I risk-based capital.................. 12.64% Total risk-based capital.................. 13.59% Leverage ratio............ 7.46%
- ------------------------ (1) As a national bank, the Bank is subject to certain minimum risk-based capital standards established by the OCC. (2) The pro forma information assumes the sale of the Common Stock in the Offering hereby and the consummation of the other transactions discussed in this prospectus, as if all such transactions had occurred on September 30, 1995. ACCOUNTING MATTERS In May 1993, the Financial Accounting Standards Board issued SFAS No. 114 "Accounting by Creditors of Impairment of a Loan" as amended by SFAS No. 118 "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures". Together, these standards require that when a loan is impaired, a creditor shall measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, the fair value of the collateral if the loan is collateral dependent or the loan's observable market price. A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The new standards also require certain disclosures regarding impaired loans. The Company adopted these standards effective January 1, 1995. The adoption of these accounting standards did not have a material effect on the Company's consolidated financial position or results of operations since the Company's recognition and measurement policies regarding nonperforming loans are materially consistent with the accounting standards. In March 1995, the FASB issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of". This Statement requires that long-lived assets and certain identifiable intangibles be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Measurement of an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold and use should be based on the fair value of the asset. This Statement is effective for fiscal years beginning after December 15, 1995. In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation". This Statement defines a fair value based method of accounting for an employee stock option or similar equity instrument and encourages all entities to adopt that method of 33 accounting for all employee stock compensation plans. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees". Entities electing to continue to use the method of accounting specified in Opinion 25 must make pro forma disclosures of net income and, if presented, earnings per share, as if the fair value method of accounting defined in this Statement had been applied. This Statement is effective for fiscal years beginning after December 15, 1995. In November 1995, the FASB issued a Financial Accounting Series Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities". The FASB concluded that concurrent with the initial adoption of this implementation guidance, but no later than December 31, 1995, an enterprise may reassess the appropriateness of the classification of all securities held at that time and account for any resulting reclassifications at fair value and such reclassifications should be disclosed in accordance with the provisions of Statement 115. Management believes that the adoption of these pronouncements will not have a material impact on the financial statements of the Company. IMPACT OF INFLATION, CHANGING PRICES AND MONETARY POLICIES The financial statements and related financial data concerning the Company presented in this prospectus have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary effect of inflation on the operations of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, changes in interest rates have a more significant effect on the performance of a financial institution than do the effects of changes in the general rate of inflation and changes in prices. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Interest rates are highly sensitive to many factors which are beyond the control of the Bank, including the influence of domestic and foreign economic conditions and the monetary and fiscal policies of the United States government and federal agencies, particularly the Federal Reserve Bank. The Federal Reserve Bank implements national monetary policy such as seeking to curb inflation and combat recession by its open market operations in United States government securities, control of the discount rate applicable to borrowing by banks and establishment of reserve requirements against bank deposits. The actions of the Federal Reserve Bank in these areas influence the growth of bank loans, investments and deposits, and affect the interest rates charged on loans and paid on deposits. The nature, timing and impact of any future changes in federal monetary and fiscal policies on the Bank and its results of operations are not predictable. See "Investment Considerations -- General Economic Conditions and Monetary Policy". 34 BUSINESS THE COMPANY Surety Finance Company, the predecessor to the Company, commenced business in 1985 as a sole proprietorship owned by C. Jack Bean and Lorene Sims Bean. On December 30, 1989 the Company acquired approximately 98% of the common stock of the Bank and subsequently increased its ownership to in excess of 99%. Prior to acquisition of the Bank, the Company operated as a casualty insurance premium finance company licensed by the State of Texas. Upon its acquisition by the Company, the Bank began operating as an insurance premium finance company, and the Company ceased writing new IPF business to allow the Bank to succeed to the existing business of the Company at that time. The Company is a registered bank holding company under the Bank Holding Company Act. The Company conducts all its operations through the Bank. The Company's principal executive offices are located at 1845 Precinct Line Road, Suite 100, Hurst, Texas 76054, and its telephone number is (817) 498-8154. At September 30, 1995 the Company had total assets of $119.6 million, total net loans of $67.9 million, total deposits of $108.2 million, and total shareholders' equity of $10.0 million. ACQUISITIONS In the past five years, the Company has increased its asset size and geographically diversified its business through a number of acquisitions. On March 22, 1993, the Company acquired First State Bank, Wells, Texas, for $1.1 million. On March 23, 1993, the Company acquired Bank of the East, Chester, Texas, for $645,676. On June 1, 1994, the Company acquired The Farmers Guaranty State Bank of Kennard for $1.2 million. The Company financed each of these three acquisitions with internally generated funds. On December 9, 1994, the Company acquired First National Bank, Whitesboro, Texas, for $6 million. The Company financed the acquisition in part through a private placement of 667,400 shares of its common stock, pursuant to which the Company raised approximately $2.2 million, and in part through a $1.75 million loan from a financial institution. As of September 30, 1995, the principal amount of the loan outstanding had been reduced to $375,000. On September 28, 1995, the Company acquired a branch located in Waxahachie, Texas (the "Waxahachie branch") from Bank One, Texas, National Association, by purchasing certain assets and assuming certain liabilities. The Company financed the acquisition with internally-generated funds. At the closing, the Company assumed deposits and other liabilities totaling approximately $16.6 million. In addition, the Company acquired certain small business and consumer loans totaling approximately $875,000, certain real property, furniture and equipment related to the Waxahachie branch totaling approximately $271,000, and cash and other assets totaling approximately $15.5 million. After paying a deposit premium totaling approximately $331,000, the Company received approximately $15.4 million in cash from Bank One as consideration for the net deposit liabilities assumed. The Waxahachie branch has been incorporated into the Bank's existing branch network. THE BANK The Bank was chartered as a national banking association in 1963. The Bank's principal offices are located at 600 South First Street, Lufkin, Texas 75901, and its telephone number is (409) 632-5541. The Bank also operates six branches in Hurst, Chester, Wells, Kennard, Waxahachie and Whitesboro, Texas. Following the completion of this Offering and the acquisition of the Midlothian Bank, the Bank's principal offices will be located in Hurst, Texas. The services offered by the Bank and its branches are generally those offered by commercial banks of comparable size in their respective areas, except that a significant portion of the Bank's loan portfolio represents IPF loans. At September 30, 1995 approximately 23%, 43% and 34% of the Bank's total loan portfolio represented commercial loans, consumer banking loans and IPF loans, respectively. 35 INSURANCE PREMIUM FINANCING IPF involves lending money to purchasers of property and casualty insurance (the "insureds") for the payment of their annual insurance premiums. This is an established type of lending, which has typically been provided by special purpose subsidiaries of major insurance companies and by finance companies. IPF ("premium financing") is generally considered a low risk form of lending for three reasons: - Approximately 25% of the annual premium must be paid by the insured at the time the insurance is purchased, so the amount of the loan represents only approximately 75% of the annual insurance premium. - At any date before the end of the policy term, a portion of the premium is not yet earned because it applies to the period from that date to the end of the policy term. This unearned premium is refunded if the policy is canceled before the end of the policy term. The amount of the premium financed is generally payable over the first nine months of the policy's term, so the unearned premium exceeds the outstanding balance of the loan and will repay the loan in full if the policy is canceled before the end of the policy term. - Even though the insured is responsible for repayment of the premium finance loan, if the insured does not make the loan payments on time, the lender has the right to cancel the policy (after notice to the insured) and to receive the entire amount of the unearned premium from the insurance carrier. The unearned premium is usually more than enough to repay the entire balance of the loan, including accrued interest. The Company has engaged in premium financing since 1986, and the business has grown in terms of volume and outstanding loan balances since that time. The following table shows the outstanding balance of premium finance loans at the end of each of the following periods: INSURANCE PREMIUM FINANCE LOANS OUTSTANDING
GROSS LOANS YEAR OUTSTANDING - --------------------------------------------------------------------- ------------- 1989................................................................. $ 4,682,321 1990................................................................. 7,061,880 1991................................................................. 8,265,490 1992................................................................. 7,267,889 1993................................................................. 14,518,680 1994................................................................. 20,931,642 September 30, 1995................................................... 24,283,325
The typical premium finance loan has a nine month life. Because of the need to bill policy holders and to promptly cancel policies when loan payments are not received in a timely fashion, this niche lending product requires highly sophisticated data processing systems. Over the past several years, the Company has developed a customized computer system, and has established a variety of policies and procedures that allow it to handle, on an integrated basis, all of the administrative aspects of this business. The Company's computer system handles the preparation of loan documents, the billing of borrowers, the preparation of notices, the calculation and billing of late charges, the notification of policy cancellations, and the preparation of premium rebate requests to insurance companies when a policy is canceled. The premium finance division, which is headed by G.M. Heinzelmann, III, is staffed by ten people and is housed in the Bank's offices in Hurst, Texas. Three of the employees of the premium finance division devote all of their time to developing and maintaining the Company's relationships with both insurance companies and insurance brokers. At the present time the Company has active relationships with approximately 400 insurance companies and approximately 3,000 insurance agents. These parties refer insurance purchasers who request financing to the Company, although in most cases the relationships are not exclusive. 36 The vast majority of insurance premiums that are financed by the Company relate to commercial property and casualty policies. Since the premiums on these policies can be quite high, many businesses prefer to pay the premiums over the course of the policy life rather than to pay the entire premium at the time the policy is purchased. Since the Company relies on a rebate of the unearned premium as collateral to pay off defaulted insurance premium loans, the Company evaluates the financial strength of the insurance company as well as the insured. In order to avoid excessive concentrations, the Company limits the dollar amount of premium financing for policies written by any single insurance company. The Company's current policy limits the aggregate loans related to any single insurance company or any insurance syndicate to a maximum of 35% of the Bank's capital. The 35% limit applies only to insurance companies rated "A" or better by A. M. Best, and to certain unrated insurance organizations which the Company's management has determined to be financially strong. Lower percentage limits apply to insurance companies which have ratings of less than "A" from A. M. Best or are not rated by A. M. Best. For example, the aggregate premium loans related to any insurance entity that is not rated by A.M. Best and is not admitted in Texas may not exceed 10% of the Bank's capital unless the Bank's board of directors authorizes a higher limit based on a review of the insurer, principally concerning its financial strength. A. M. Best is the most widely recognized rater of insurance companies in the United States. A. M. Best only rates companies that have been in business for five years, and these companies are rated using the following system: A++, A+......................................... Superior A, A-........................................... Excellent B++, B+......................................... Very Good B, B-........................................... Adequate C++,C+.......................................... Fair C, C-........................................... Marginal
In addition to these six ratings, A. M. Best has a variety of ratings for companies for which the normal six ratings are not applicable. These additional ratings simply indicate the reason no rating is assigned and are not necessarily qualitative assessments. Set forth below is a table showing a breakdown of the Company's premium financing loans outstanding as of September 30, 1995 by the type and where applicable the rating of the entity providing the insurance. BREAKDOWN BY TYPE OF INSURING ENTITY Insurance companies rated "A++, A+, A or A-" by A. M. Best......... 54.6% Insurance companies rated "B++, B+, B or B-" by A. M. Best......... 8.0% Texas Workers Compensation Insurance Fund.......................... 12.2% Insurance syndicates operating through established insurance exchanges......................................................... 7.3% Non-rated insurance companies admitted in Texas.................... 14.3% Non-rated insurance companies not admitted in Texas................ 3.6% ----- Total.......................................................... 100.0% ----- -----
The Company believes that the structure of these loans results in limited credit losses. The Company may incur losses in its IPF business for a number of reasons, including fraud, refusal of an insurance company to refund a premium, insurance company insolvency, failure of the Company to properly notify an insurance company of the Company's interest in unearned premiums under applicable law and other reasons. The Company's loss experience on insurance premium finance lending was adversely affected during the second half of 1991 by the failure of a non-rated insurance company. Since 1991, the Company has limited its exposure to non-rated companies, as described above, and has experienced no net loan losses on premium financing loans. See "Management's Discussion and Analysis of Financial Conditions and Results of Operations -- Allowance for Loan Losses". 37 MEDICAL RECEIVABLES FACTORING The Company has engaged in medical receivables factoring since 1990. Medical receivables factoring involves the purchase of accounts receivable from doctors, hospitals, and other health care organizations. These accounts receivable are due principally from major insurance companies and governmental agencies. These receivables are purchased by the Company at a price equal to approximately 50% to 60% of their face amount. When the receivable is paid the Company retains the purchase price it paid for the receivables plus a discount factor and a servicing fee. The remaining balance of the payment is paid to the party from which the receivable was initially purchased. The turnover in the Company's medical receivables portfolio is rapid and is attributable to each factored receivable having an average life of approximately nine weeks. During the nine months ended September 30, 1995, the yield on the funds committed to this activity was 18.1%. The administration of the medical receivables is handled for the Company by Providers Funding Corporation ("PFC"), a company which specializes in the acquisition and processing of medical receivables. PFC has developed specialized computer systems which automate much of the administration of the medical receivables. In addition to a review of the receivables conducted by PFC, the Company has two individuals who conduct secondary review of the receivables to make sure that they meet the Company's criteria. The Company has experienced no losses in its medical receivables factoring business since the Company began this type of lending in 1990. However, the Company could incur losses in its medical receivables factoring business for a number of reasons, including fraud and the failure of the insurance company or the government agency to pay the receivable for any reason. The Company generally has no recourse against the health care provider for payment of a medical receivable which is not otherwise paid, although the Company generally obtains and perfects a security interest in all medical receivables of that health care provider to secure payment of the receivables. Therefore, payments on any other receivable in excess of the balance due the Company regarding that receivable may, under certain circumstances, be applied to an unpaid receivable. Medical receivables factoring, like IPF, is a specialty type of financing which provides high yields and requires specialized expertise and systems. The Company considers the market for this type of financing to be relatively broad, and to extend beyond the local markets served by the Bank's branches. COMMERCIAL AND CONSUMER BANKING The Bank provides general commercial banking services for corporate and other business clients through its main office located in Angelina County, Texas, and through its branches located in Tarrant County, Tyler County, Cherokee County, Houston County, Ellis County and Grayson County, Texas as a part of the Bank's efforts to serve the local communities in which it operates. These loans are generally made to provide working capital, to finance the purchase of equipment, and for the expansion of existing businesses. The Bank's loans are secured by the assets of the businesses, including real estate, inventories, receivables, equipment and cash. Virtually all of these loans are also guaranteed by the owners of the businesses. The commercial loan portfolio also includes a significant amount of agricultural loans to farmers and ranchers. These loans are normally secured by equipment, crops, livestock, real estate and cash. The average yield during the nine months ended September 30, 1995 for the Bank's commercial lending activities was 10.9%. The Bank's commercial loans generally have maturities of twelve months or less. The Bank provides a full range of consumer banking services, including checking accounts, "NOW" and "money market" accounts, savings programs, installment and real estate loans, money transfers and safe deposit facilities. COMPETITION There is significant competition among banks and bank holding companies in Angelina County, Tarrant County, Tyler County, Cherokee County, Houston County, Ellis County, and Grayson County, Texas, and the Company believes that such competition among such banks and bank holding companies, many of which have far greater assets and financial resources than the Company, will continue to increase in the future. The Bank also encounters intense competition in its commercial and consumer banking business from savings and loan associations, credit unions, factors, insurance companies, commercial and captive finance companies, and certain other types of financial institutions located in other major metropolitan areas in the United 38 States, many of which are larger in terms of capital, resources and personnel. The casualty IPF business of the Bank is also very competitive. Large insurance companies offer their own financing plans, and other independent premium finance companies and other financial institutions offer IPF loans. EMPLOYEES As of September 30, 1995 the Company and the Bank collectively had 92 full-time employees and two part-time employees. None of the Company's or the Bank's employees are subject to a collective bargaining agreement, and the Company and the Bank believe that their respective employee relations are good. PROPERTIES The Bank has seven banking facilities. The Bank's main office is currently located in Lufkin, Texas, and the Bank's six branches are located in Hurst, Chester, Wells, Kennard, Waxahachie and Whitesboro, Texas. Upon consummation of the acquisition of Midlothian Bank, which will become the Bank's seventh branch, the Bank plans to move its main office to Hurst, Texas, and the Lufkin office will become a branch facility. The Lufkin facility is a two-story building located at 600 South First Street, Lufkin, Texas 75901. This building and the underlying tract of land are owned by the Bank. The building includes approximately 10,000 square feet of office space. A detached motor bank facility is also located on the land. The Hurst banking facility is located at 1845 Precinct Line Road, Suite 100, Hurst, Texas 76054. The Company and a branch of the Bank occupy approximately 13,000 square feet of leased space in a two-story building under a lease dated February 14, 1994 for a term of five years and ten months beginning March 1, 1994 and ending on December 31, 1999. The Chester facility is located in a two-story building located on U.S. Highway 287 in Chester, Texas. This building, and the underlying tract of land consisting of approximately 15,000 square feet, are owned by the Bank. The building includes approximately 5,600 square feet of office space. The Bank also owns an improved tract of land (containing approximately 3,000 square feet) located adjacent to the Chester facility. The Wells facility is located in a one-story building located on U.S. Highway 69 in Wells, Texas. This building, and the underlying tract of land consisting of approximately 9,000 square feet, are owned by the Bank. The building includes approximately 4,500 square feet of office space. The Bank also owns two unimproved tracts of land (one containing approximately 2.31 acres and the other approximately 1,800 square feet) located adjacent to the Wells facility. The Kennard facility is located in a one-story building located at Broadway and Main Streets, in Kennard, Texas. This building, and the underlying tract of land consisting of approximately 14,000 square feet, are owned by the Bank. The building includes approximately 2,790 square feet of office space. The Bank also owns two storage buildings located on the same tract of land. The Waxahachie facility is located in a two-story building located at 104 Elm Street, Waxahachie, Texas 75165. This building, and the underlying tract of land consisting of approximately 14,100 square feet, are owned by the Bank. The building includes approximately 5,100 square feet of office space. The Whitesboro facility is located in a one-story building located at 2500 Highway 82 East, in Whitesboro, Texas. This building, and the underlying tract of land consisting of approximately 132,000 square feet, are owned by the Bank. The building includes approximately 6,400 square feet of office space. The Company believes the existing facilities are adequate for its present needs. REGULATION AND SUPERVISION GENERAL The Company and the Bank are subject to the generally applicable state and federal laws governing businesses and employers. The Company and the Bank are further extensively regulated by special state and federal laws and regulations applicable only to financial institutions and their parent companies. Virtually all aspects of the Company's and Bank's operations are subject to specific requirements or restrictions and general regulatory oversight, from laws regulating consumer finance transactions, such as the Truth in 39 Lending Act, the Home Mortgage Disclosure Act and the Equal Credit Opportunity Act, to laws regulating collections and confidentiality, such as the Fair Debt Collection Practices Act, the Fair Credit Reporting Act and the Right to Financial Privacy Act. With few exceptions, state and federal banking laws have as their principal objective either the maintenance of the safety and soundness of financial institutions and the federal deposit insurance system or the protection of consumers or classes of consumers, rather than the specific protection of shareholders of the Company. To the extent that the following discussion describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation. Any change in applicable laws, regulations or policies of various regulatory authorities may have a material effect on the business, operations and prospects of the Company and the Bank. The Company is unable to predict the nature or the extent of the effects on its business or earnings that fiscal or monetary policies, economic control or new federal or state legislation may have in the future. REGULATION OF THE COMPANY The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended ("BHCA"), and therefore is subject to regulation and supervision by the FRB. The Company is required to file reports with, and to furnish such other information as, the FRB may require pursuant to the BHCA, and to subject itself to examination by the FRB. The FRB has the authority to issue orders to bank holding companies to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil monetary penalties against companies or individuals who violate the BHCA or orders or regulations thereunder, to order termination of non-banking activities of non-banking subsidiaries of bank holding companies, and to order termination of ownership and control of a non-banking subsidiary by a bank holding company. Certain violations may also result in criminal penalties. The OCC is authorized to exercise comparable authority with respect to the Bank. The FRB takes the position that a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the FRB's position that, in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of the FRB regulations or both. This doctrine has become known as the "source of strength" doctrine. In addition, statutory changes in the Federal Deposit Insurance Act (the "FDIA") made by the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") now require the holding company parent of an undercapitalized bank to guarantee, up to certain limits, the bank's compliance with a capital restoration plan approved by the bank's primary federal supervisory agency. The BHCA and the Change in Bank Control Act, together with regulations promulgated by the FRB, require that, depending on the particular circumstances, either FRB approval must be obtained or notice must be furnished to the FRB and not disapproved prior to any person or company acquiring "control" of a bank holding company, such as the Company, subject to certain exemptions for certain transactions. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more but less than 25% of any class of voting securities and either the company has registered securities under Section 12 of the Securities Exchange Act of 1934, as amended, or no other person will own a greater percentage of that class of voting securities immediately after the transaction. The regulations provide a procedure for challenge of the rebuttable control presumption. Control is rebuttably presumed not to exist if a company acquires less than 5% of any class of voting securities of a bank or a bank holding company. As a bank holding company, the Company is required to obtain approval prior to merging or consolidating with any other bank holding company, acquiring all or substantially all of the assets of any bank or 40 acquiring ownership or control of shares of a bank or bank holding company if, after the acquisition, the Company would directly or indirectly own or control 5% or more of the voting shares of such bank or bank holding company. The Company is also prohibited from acquiring a direct or indirect interest in or control of more than 5% of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks, except that it may engage in and may own shares of companies engaged in certain activities found by the FRB to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. These activities include, among others, operating a mortgage, finance, credit card, or factoring company; performing certain data processing operations; providing investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full-payout, non-operating basis; and providing certain stock brokerage and investment advisory services. In approving acquisitions or the addition of activities, the FRB considers whether the acquisition or the additional activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh such possible adverse effects as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. In considering any application for approval of an acquisition or merger, the FRB is also required to consider the financial and managerial resources of the companies and the banks concerned, as well as the applicant's record of compliance with the Community Reinvestment Act (the "CRA"). The BHCA generally imposes certain limitations on transactions by and between banks that are members of the Federal Reserve System and other banks and non-bank companies in the same holding company structure, including limitations on extensions of credit (including guarantees of loans) by the Bank to affiliates, investments in the stock or other securities of the Company by the Bank, and the nature and amount of collateral that the Bank may accept from any affiliate to secure loans extended to the affiliate. The Company, as an affiliate of the Bank, is also subject to these restrictions. Under the BHCA and the FRB's regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. As of September 30, 1995, the Riegle-Neal Interstate Banking and Branching Act of 1994 (the "Interstate Banking Act") allows adequately capitalized and managed bank holding companies to acquire banks in any state, regardless of whether the acquisition would be prohibited by applicable state law. An out-of-state bank holding company seeking to acquire ownership or control of a Texas state bank, a national bank located in Texas or any bank holding company owning or controlling a state bank or a national bank located in Texas must obtain the prior approval of both the FRB and the Banking Commissioner of Texas. In addition, under the Interstate Banking Act, a bank holding company and its insured depository institution affiliates may not complete an acquisition which would cause it to control more than 10% of total deposits in insured depository institutions nationwide or to control 30% or more of total deposits in insured depository institutions in the home state of the target bank. However, state deposit concentration caps adopted by various states, such as the State of Texas, which limit control of in-state insured deposits to a greater extent than the Interstate Banking Act will be given effect. The State of Texas has adopted a deposit concentration cap of 25% of in-state insured deposits; therefore, the Texas state deposit concentration cap will lower the otherwise applicable 30% federal deposit concentration cap. Additionally, state provisions regarding the minimum years the target has been in existence will be honored; provided, however, acquisitions may be approved when the target bank has been in existence for at least five years, notwithstanding state provisions to the contrary. The minimum age provision adopted by the State of Texas is five years and therefore this provision will not be preempted by the federal provision. The Interstate Banking Act will also allow out-of-state branches through interstate mergers commencing June 1, 1997, provided that each bank involved in the merger is adequately capitalized and managed. States are permitted, however, to pass legislation either providing for earlier approval of mergers with out- of-state banks or "opting-out" of interstate mergers entirely, provided such legislation applies equally to all 41 out-of-state banks. Texas has passed legislation to "opt out" of interstate mergers entirely until 1999. The Interstate Banking Act also provides for interstate mergers involving an out-of-state bank's acquisition of a branch of an insured bank without the acquisition of the entire bank, if permitted under the laws of the state where the branch is located. The deposit concentration caps and the minimum age provisions applicable to interstate bank acquisitions also apply to interstate bank mergers. The Interstate Banking Act also provides for de novo branches in a state if that state expressly elects to permit de novo branching on a non-discriminatory basis. A "de novo branch" is defined as a branch office of a national or state bank that is originally established as a branch and does not become a branch as a result of an acquisition, conversion, merger or consolidation. De novo interstate branching is subject to the same conditions applicable to interstate mergers under the Interstate Banking Act, other than deposit concentration limits. REGULATION OF THE BANK The Bank is a national banking association and therefore is subject to regulation, supervision, and examination by the OCC. The Bank is also a member of the FRB and the FDIC. Requirements and restrictions under the laws of the United States include the requirement that reserves be maintained against deposits, restrictions on the nature and the amount of loans which can be made, restrictions on the business activities in which a bank may engage, restrictions on the payment of dividends to shareholders, and minimum capital requirements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Capital Resources". As discussed above, the OCC has enforcement authority over the Bank that is similar to that of the FRB with respect to the Company. In addition, upon making certain determinations with respect to the condition of any insured national bank, such as the Bank, the FDIC may begin to terminate a bank's federal deposit insurance. There are certain statutory limitations on the payment of dividends by national banks. Without approval of the OCC, dividends may not be paid in excess of a bank's total net profits for that year, plus its retained profits for the preceding two years, less any required transfers to capital surplus. In addition, a national bank may not pay dividends in excess of total retained profits, including current year's earnings. In some cases, the OCC may find a dividend payment that meets these statutory requirements to be an unsafe or unsound practice. Federal and Texas state laws generally limit the amount of interest and fees which lenders, including the Bank, may charge regarding loans. The applicable law, and the applicable limits, may vary depending upon, among other things, the identity, nature and location of the lender, and the type of loan or collateral. In Texas, the maximum interest rate applicable to most loans changes with changes in the average auction rate for United States Treasury Bills, but does not decline below 18% or rise above 24% (except for certain loans in excess of $250,000 for which the maximum annual rate may not rise above 28%). However, the interest which may be charged on an IPF loan is regulated by the Texas State Board of Insurance. See "Business -- Insurance Premium Financing". National banks domiciled in Texas are permitted to engage in unlimited branch banking, subject to the prior approval of the OCC to establish any branch. Banks are affected by the credit policies of other monetary authorities, including the FRB, which affect the national supply of bank credit. Such policies influence overall growth of bank loans, investments, and deposits and may also affect interest rates charged on loans and paid on deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. FDICIA requires the OCC to take "prompt corrective action" with respect to any national bank which does not meet specified minimum capital requirements. The applicable regulations establish five capital levels, ranging from "well-capitalized" to "critically undercapitalized," and require or permit the OCC to take supervisory action regarding any national bank that is not at least "adequately capitalized". Under these regulations, which became effective December 19, 1992, a national bank is considered well capitalized if it has a total risk-based capital ratio of 10.0% or greater, a Tier I risk-based capital ratio of 6.0% or greater, 42 and a leverage ratio of 5.0% or greater, and it is not subject to an order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. A national bank is considered "adequately capitalized" if it has a total risk-based capital ratio of 8.0% or greater, a Tier I risk-based capital ratio and leverage capital ratio of 4.0% or greater (or a leverage ratio of 3.0% or greater if the institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines), and the institution does not meet the definition of an undercapitalized institution. A national bank is considered "undercapitalized" if it has a total risk-based capital ratio that is less than 8%, a Tier I risk-based capital ratio that is less than 4%, or a leverage ratio that is less than 4.0% (or a leverage ratio that is less than 3.0% if the institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines). A "significantly undercapitalized" institution is one which has a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0%, or a leverage ratio that is less than 3.0%. A "critically undercapitalized" institution is one which has a ratio of tangible equity to total assets that is equal to or less than 2.0%. With certain exceptions, national banks will be prohibited from making capital distributions or paying management fees if the payment of such distributions or fees will cause them to become undercapitalized. Furthermore, undercapitalized national banks will be required to file capital restoration plans with the OCC. Undercapitalized national banks also will be subject to restrictions on growth, acquisitions, branching and engaging in new lines of business unless they have an approved capital plan that permits otherwise. The OCC also may, among other things, require an undercapitalized national bank to issue shares or obligations, which could be voting stock, to recapitalize the institution or, under certain circumstances, to divest itself of any subsidiary. The OCC is authorized to take various enforcement actions against any significantly undercapitalized national bank and any undercapitalized national bank that fails to submit an acceptable capital restoration plan or fails to implement a plan accepted by the OCC. The powers include, among other things, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any bank holding company which controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring a new election of directors, and requiring the dismissal of directors and officers. Significantly and critically undercapitalized national banks may be subject to more extensive control and supervision. The OCC may prohibit any such institutions from, among other things, entering into any material transaction not in the ordinary course of business, amending their charters or bylaws, or engaging in certain transactions with affiliates. In addition, critically undercapitalized institutions generally will be prohibited from making payments of principal or interest on outstanding subordinated debt. Within 90 days of a national bank's becoming critically undercapitalized, the OCC must appoint a receiver or conservator unless certain findings are made with respect to the prospect for the institution's continued viability. Based on its capital ratios as of September 30, 1995, the Bank was classified as "well capitalized" under the applicable regulations. The Company does not believe that FDICIA's prompt corrective action regulations will have any material effect on the activities or operations of the Bank. However, if the Bank were to become undercapitalized and these restrictions were to be imposed, the restrictions, either individually or in the aggregate, could have a significant adverse effect on the operations of the Bank, and, as a result, the ability of the Company to pay dividends on the Common Stock or service any cash flow needs. CURRENT REGULATORY ISSUES In late 1993, the Secretary of the Treasury of the United States proposed a wide-ranging restructuring of the bank regulatory system in the United States, including the merger or other combination of the FRB, the OCC and the FDIC, among others. As of the date of this prospectus, the legislation to effect such a restructuring has not yet been introduced in Congress and there can be no certainty as to the effect, if any, that such legislation would have on the regulation of the Company or the Bank. 43 FDICIA requires the FDIC to establish a schedule to increase (over a period of not more than 15 years) the reserve ratio of the BIF, which insures the deposits of the Bank to a maximum of $100,000 per depositor, to 1.25% of insured deposits, and impose higher deposit insurance premiums of BIF members, if necessary, to achieve that ratio. Generally, banks are assessed insurance premiums according to how much risk they are deemed to present to BIF. Such premiums ranged from 0.23% of insured deposits to 0.31% of insured deposits in 1994 and 1995. Banks with higher levels of capital and which have earned a low degree of supervisory concern are assessed lower premiums than banks with lower levels of capital or a higher degree of supervisory concern. During 1994 and 1995 (until a new rate structure) the Bank was assessed at the rate of $0.23 per $100 of deposits. On August 8, 1995, the FDIC Board of Directors voted to significantly reduce the deposit insurance premium paid by most banks but to keep existing assessment rates intact for savings associations. Under the new rate structure, which went into effect in October, 1995, the highest rated institutions insured by BIF pay $0.04 per $100 of domestic deposits. Based on the risk category applicable to the Bank, the premium paid by the Bank is presently $.04 per $100 of deposit. On November 14, 1995, the FDIC announced that commencing in 1996 it would eliminate insurance deposit premiums for all but the banks warranting the highest level of supervisory concern. FDICIA contains numerous other provisions, including new accounting, auditing and reporting requirements, the termination (beginning in 1995) of the "too big to fail" doctrine except in special cases, new regulatory standards in areas such as asset quality, earnings and compensation and revised regulatory standards for the powers of state chartered banks, real estate lending, bank closures and capital adequacy. Under CRA, a bank's applicable regulatory authority (which is the OCC for the Bank) is required to assess the record of each financial institution which it regulates to determine if the institution meets the credit needs of its entire community, including low- and moderate-income neighborhoods served by the institution, and to take that record into account in its evaluation of any application made by such institution for, among other things, approval of the acquisition or establishment of a branch or other deposit facility, an office relocation, a merger, or the acquisition of shares of capital stock of another financial institution. The regulatory authority prepares a written evaluation of an institution's record of meeting the credit needs of its entire community and assigns a rating. The Bank has undertaken significant actions to comply with the CRA. The Bank has received a "satisfactory" commendation in its most recent review by federal regulators with respect to its compliance with the CRA. Both the United States Congress and the banking regulatory authorities have proposed substantial changes to the CRA and fair lending laws, rules and regulations, and there can be no certainty as to the effect, if any, that any such changes would have on the Bank. CAPITAL ADEQUACY GUIDELINES Capital management consists of providing equity to support both current and future operations. The Company is subject to capital adequacy requirements issued by the FRB, and the Bank is subject to similar requirements imposed by the OCC. Specifically, the various federal bank regulatory agencies, including the FRB and the OCC, have adopted risk-based capital requirements for assessing bank holding company and bank capital adequacy. These standards define capital and establish minimum capital requirements in relation to assets and off-balance sheet exposure, adjusted for credit risk. The risk-based capital standards currently in effect are designed to make regulatory capital requirements more sensitive to differences in risk profile among bank holding companies and banks, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate relative risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. On September 14, 1993, the FRB together with the FDIC and the OCC jointly proposed new rules implementing an interest rate risk ("IRR") component to the risk-based standards as required by FDICIA. The effect the proposed IRR rule will have on the Bank's risk-based capital requirements, if any, cannot be determined until the rule is finalized. The minimum standard for the ratio of capital to risk-weighted assets (including certain off-balance sheet obligations, such as standby letters of credit) is 8.0%. At least half of the risk-based capital must consist of common equity, retained earnings, and qualifying perpetual preferred stock, less deductions for goodwill 44 and various other intangibles ("Tier I capital"). The remainder may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, preferred stock, and a limited amount of the general valuation allowance for loan losses ("Tier II capital"). The sum of Tier I capital and Tier II capital is "total risk-based capital." The FRB (for the Company) and the OCC (for the Bank) have also adopted guidelines which supplement the risk-based capital guidelines with a minimum leverage ratio of Tier I capital to average total consolidated assets ("leverage ratio") of 3% for institutions with well diversified risk (including no undue interest rate exposure; excellent asset quality; high liquidity; good earnings); that are generally considered to be strong banking organizations (rated composite 1 under applicable federal guidelines); and that are not experiencing or anticipating significant growth. Other banking organizations are required to maintain a leverage ratio of at least 4.0% to 5.0%. These rules further provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels and comparable to peer group averages, without significant reliance on intangible assets. The FRB continues to consider a "tangible Tier I leverage ratio" in evaluating proposals for expanding activities by bank holding companies. The tangible Tier I leverage ratio is the ratio of a banking organization's Tier I capital (less deductions for intangibles otherwise includable in Tier I capital) to total tangible assets. As of September 30, 1995, the Company's Tier I risk-based capital ratio was 10.17%, its total risk-based capital ratio was 11.14% and its leverage ratio was 6.4%, which equaled or exceeded the federal minimum regulatory requirements. Bank regulators may raise capital requirements applicable to banking organizations beyond current levels. However, the Company is unable to predict whether higher capital requirements will be imposed and, if so, at what levels and on what schedules, and therefore cannot predict what effect such higher requirements may have on the Company and the Bank. For an analysis of the Company's and the Bank's capital, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Capital Resources." 45 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The Company elected eight directors at the annual meeting of the shareholders in April 1995. All directors are elected annually and hold office until the next annual meeting of shareholders, expected to be held in May 1996, or until their respective successors have been duly elected and have qualified. The following table provides information, as of November 15, 1995, about the directors and executive officers of the Company.
NAME AND AGE; YEARS SERVED AS DIRECTOR PRINCIPAL OCCUPATION FOR PAST FIVE YEARS; OTHER DIRECTORSHIPS - --------------------------- ----------------------------------------------------------------------------------- C. Jack Bean C. Jack Bean has been Chairman of the Board and a director of the Company since Age 67 March 1987, and served as President of the Company from March 1987 to July 1992. Director Since 1987 Mr. Bean was the owner and founder of Surety Finance Company, the predecessor company to the Company's business, from 1985 until March 1987. He has served as Chairman of the Board and a director of the Bank since December 1989. G. M. Heinzelmann, III G. M. Heinzelmann, III has been President of the Company since July 1992 and a Age 33 director of the Company since July 1993. He previously served as Vice President of Director Since 1993 the Company from May 1987 to July 1992. Mr. Heinzelmann has served as Senior Vice President and a director of the Bank since December 1989 and as Manager of the Insurance Premium Finance Division of the Company, and subsequently the Bank, since May 1987. He has also served as Secretary, Treasurer and a director of Brian Capital, Inc., a non-operating publicly held corporation, since November 1988. Bobby W. Hackler Bobby W. Hackler has been Vice President and Secretary of the Company since January Age 49 1992. He served as Chief Financial Officer of the Company from January 1992 to Director Since 1994 October 1995. He has served as President of the Bank since February 1994, as Chief Executive Officer of the Bank since July 1992, and as a director of the Bank since December 1990. Mr. Hackler previously served as the Bank's Chief Operating Officer from January 1992 to July 1992, as its Senior Vice President and Controller from March 1991 to December 1991, and as its Vice President and Controller from January 1990 to March 1991. William B. Byrd William B. Byrd has served as a director of the Company since April 1993. He has Age 63 been involved in personal investment activities, real estate brokerage and Director Since 1993 management, and ranching for the past five years. Mr. Byrd has served as a director of the Bank since January 1994. Joseph S. Hardin Joseph S. Hardin has served as a director of the Company since April 1989. He has Age 79 been involved in personal investment activities for the past five years. Mr. Director Since 1989 Hardin has served as a director of the Bank since May 1994. Michael L. Milam Michael L. Milam has served as a director of the Company since May 1994. He has Age 42 been president of Dallas Fire Insurance Company, a licensed Texas stock insurance Director Since 1994 company, since December 1988. Mr. Milam has served as a director of the Bank since May 1994. Garrett Morris Garrett Morris has served as a director of the Company since May 1994. He has been Age 69 a member of the law firm of Morris and Schiffer since 1989. Mr. Morris has served Director Since 1994 as a director of the Bank since May 1994. Cullen W. Turner Cullen W. Turner has served as a director of the Company since March 1987. He has Age 54 been involved in personal investment activities for the past five years. Mr. Director Since 1987 Turner has served as a director of the Bank since December 1993.
46
NAME AND AGE; YEARS SERVED AS DIRECTOR PRINCIPAL OCCUPATION FOR PAST FIVE YEARS; OTHER DIRECTORSHIPS - --------------------------- ----------------------------------------------------------------------------------- B. J. Curley B.J. Curley has served as the Company's Chief Financial Officer and Vice President Age 31 since October 1995. Since December 1994 he has served as Chief Financial Officer of the Bank and since May 1993 has served as the Bank's Controller. Prior to May, 1993, he served as controller for Environmental Engineering & Geotechnics.
G. M. Heinzelmann, III, President and a director of the Company, is the son-in-law of C. Jack Bean, Chairman of the Board of the Company. Otherwise, there is no family relationship between any of the directors and any executive officer of the Company. EXECUTIVE COMPENSATION AND OTHER INFORMATION SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION. The following table provides certain summary information concerning compensation paid or accrued by the Company to or on behalf of the Company's Chairman of the Board and Chief Executive Officer and each of the two other most highly compensated executive officers of the Company (determined as of the end of the last fiscal year) (hereafter referred to as the "named executive officers") for the fiscal years ended December 31, 1994, 1993 and 1992: SUMMARY COMPENSATION TABLE ANNUAL COMPENSATION
NAME AND SALARY OTHER ANNUAL ALL OTHER PRINCIPAL POSITION YEAR ($)(1) BONUS ($) COMPENSATION ($)(2) COMPENSATION ($)(3) - -------------------------------------------- --------- ------------ ----------- -------------------- ------------------- C. Jack Bean 1994 $ 107,653 $ 14,500 $ 3,740 Chairman of the Board and Chief 1993 $ 87,740 $ 8,700 $ 2,126 Executive Officer of the Company; 1992 $ 80,200 $ 8,458(4) Chairman of the Board of the Bank G. M. Heinzelmann, III 1994 $ 71,872 $ 10,100 $ 2,600 President of the Company; Senior 1993 $ 60,855 $ 6,050 $ 1,477 Vice President of the Bank 1992 $ 56,200 $ 7,012(5) Bobby W. Hackler Vice President, Secretary and Chief 1994 $ 78,879 $ 11,100 $ 2,857 Financial Officer of the Company; 1993 $ 66,793 $ 6,650 $ 1,623 President and Chief Executive Officer 1992 $ 61,200 $ 7,620(6) of the Bank
- ------------------------ (1) Includes salary and directors' fees paid by the Company, before any salary reduction for contributions in 1994 and 1993 to the Company's Savings Plan under Section 401(k) of the Internal Revenue Code of 1986, as amended (the "Code"). (2) Excludes perquisites and other personal benefits, securities, or property which, in the aggregate, do not exceed the lesser of $50,000 or ten percent (10%) of the annual salary and bonus, if any, for each named executive officer. (3) The total amounts shown in this column consist of matching contributions under the Company's Savings Plan under Section 401(k) of the Code, which was adopted by the Company in 1993. (4) Consists of $6,778 which represents the estimated value of the incidental personal use of an automobile owned by the Bank, and $1,680 which represents country club membership dues paid by the Bank. (5) Consists of $5,272 which represents the estimated value of the incidental personal use of an automobile owned by the Bank, and $1,740 which represents country club membership dues paid by the Bank. (6) Consists of $6,000 which represents an automobile allowance paid by the Bank, and $1,620 which represents country club membership dues paid by the Bank. 47 1995 STOCK OPTION PLAN. At the annual meeting in April, 1995, the shareholders of the Company adopted the 1995 Incentive Stock Option Plan of Surety Capital Corporation (the "1995 Stock Plan"). The purpose of the 1995 Stock Plan is to permit officers and key employees of the Company and its subsidiaries (whether now owned or hereafter acquired) to acquire a proprietary interest in the Company, thereby providing them with an additional incentive for further promoting the success of the Company's business operations and encouraging them to remain as officers and key employees of the Company and its subsidiaries. All executive officers and other key personnel of the Company who are active, full-time employees of the Company or its subsidiaries, and who otherwise qualify under the 1995 Stock Plan, are eligible to participate in the 1995 Stock Plan. However, members of the Board who are not employed by the Company or any of its subsidiaries on a full time basis are not eligible to participate in the 1995 Stock Plan. The 1995 Stock Plan is administered by the Stock Option Committee (the "Committee"), which is comprised of five members of the Board, none of whom are eligible to receive options under the 1995 Stock Plan while serving as a member of the Committee and who have been ineligible to receive options under the 1995 Stock Plan or any other stock option or stock appreciation rights plan of the Company (including the 1988 Incentive Stock Option Plan of the Company) for a period of at least one year prior to the date of their appointment as a member of the Committee. The Committee is empowered (i) to construe and interpret the 1995 Stock Plan and all options granted thereunder, (ii) to recommend the individuals to whom and the time or times at which options will be granted, the number of shares to be subject to each option and the option exercise price, and (iii) to make all other determinations necessary or advisable for the administration of the 1995 Stock Plan. Subject to provisions for proportionate adjustment occasioned by changes in the Company's capital structure, a total of 100,000 shares of Common Stock of the Company have been set aside under the 1995 Stock Plan for use upon exercise of options granted thereunder. As of November 30, 1995 no options have been granted under the 1995 Stock Plan. Options under the 1995 Stock Plan must be granted on or before February 20, 2005, and the options by their terms may not be exercised after ten years from the date the options are granted. The exercise price for options granted under the 1995 Stock Plan is determined by the Committee, except that in no event may such exercise price be less than the fair market value of the Company's Common Stock on the date of the grant. In the event an option is granted to a person who, at the time the option is granted, owns stock possessing more than ten percent of the total combined voting power of all classes of stock of the Company, the exercise price at the time the option is granted must be at least 110% of the fair market value of the Company's Common Stock. The aggregate fair market value (determined at the time the options are granted) of the Company's Common Stock with respect to which options of a participant are exercisable for the first time during any calendar year under the 1995 Stock Plan, together with any options granted to such participant under any other plan of the Company or its subsidiaries, may not exceed $100,000. The proceeds from the sale of shares of Common Stock pursuant to options granted under the 1995 Stock Plan will constitute general corporate funds of the Company. 48 OPTION GRANTS As of September 30, 1995, the three executive officers named below held options granted under the Company's 1988 Incentive Stock Option Plan (the "1988 Plan") covering 55,216 shares of Common Stock. No additional options may be granted under the 1988 Plan. The following table provides information on incentive stock options granted in fiscal year 1994 to the named executive officers: OPTION GRANTS IN FISCAL YEAR 1994 (1)
INDIVIDUAL GRANTS POTENTIAL REALIZABLE ---------------------------------- VALUE AT ASSUMED ANNUAL NUMBER OF RATES OF STOCK PRICE SECURITIES PERCENT OF TOTAL APPRECIATION FOR OPTION UNDERLYING OPTIONS GRANTED EXERCISE OR TERM OPTIONS TO EMPLOYEES IN BASE PRICE EXPIRATION ------------------------ NAME GRANTED (#)(2) FISCAL YEAR ($/SH)(3) DATE 5% ($)(4) 10% ($)(4) - ---------------------------------- --------------- ----------------- ------------ ----------- ----------- ----------- C. Jack Bean...................... 4,100 41% $ 4.95(5) 1-12-99 $ 3,252 $ 9,419 G. M. Heinzelmann, III............ 2,800 28% $ 4.50 1-12-99 $ 3,481 $ 7,692 Bobby W. Hackler.................. 3,100 31% $ 4.50 1-12-99 $ 3,854 $ 8,517
- ------------------------ (1) This table reflects incentive stock options granted on January 12, 1994 under the Company's 1988 Plan to the named executive officers. These options vested on the date of grant. The options have been granted for a term of five years, subject to earlier termination upon the occurrence of certain events related to termination of employment. See "-- 1995 Stock Option Plan" for a discussion of the 1995 Stock Plan. (2) Under the terms of the 1988 Plan, the Committee retains the discretion, subject to the 1988 Plan limits, to modify the terms of outstanding options. (3) Except as otherwise indicated, based on 100% of the fair market value of the shares underlying options on the date of grant. (4) The dollar amounts under these columns are the result of calculations of the potential realizable value under the 5% and 10% rates set by the Securities and Exchange Commission. The assumed appreciation rates of 5% and 10% (compounded annually on the $4.50 market value at date of grant) from the date of grant are not intended to forecast possible future appreciation, if any, of the Company's stock price. These amounts show potential realizable value of the options at the end of the five year term. (5) Based on 110% of the fair market value of the shares underlying options on the date of grant. OPTIONS EXERCISES AND HOLDINGS. The following table provides information with respect to the named executive officers concerning the exercise of incentive stock options during the last fiscal year and unexercised incentive stock options held as of the end of the last fiscal year under the 1988 Plan: AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES
VALUE OF UNEXERCISED NUMBER OF IN-THE-MONEY UNEXERCISED OPTIONS AT OPTIONS AT FY-END ($) FY-END (#) ---------------- VALUE ------------- EXERCISABLE/ SHARES ACQUIRED ON REALIZED EXERCISABLE/ UNEXERCISABLE NAME EXERCISE (#) ($)(1) UNEXERCISABLE (2) - ----------------------------------------------------- --------------------- ------------- ------------- ---------------- C. Jack Bean......................................... 0 $ 0 11,900/-0- $ -0-/-0- G. M. Heinzelmann, III............................... 0 $ 0 10,785/-0- $11,509.00/-0- Bobby W. Hackler..................................... 0 $ 0 9,026/-0- $ 9,687.50/-0-
- ------------------------ (1) No incentive stock options were exercised in 1994 by the named executive officers. (2) Market value of underlying securities as of the fiscal year-end ($3.125), minus the exercise or base price. 49 TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL AGREEMENTS The Company has entered into termination of employment and change in control agreements with certain of its employees. While these agreements were not adopted to deter takeovers, they may have an incidental anti-takeover effect by making it more expensive for a bidder to acquire control of the Company. The Company believes that these agreements are in the best interest of the Company in order to encourage the continued attention and dedication of members of the Company's management to their assigned duties without distraction in the face of potentially disturbing circumstances arising from the possibility of a change in control of the Company. Specifically, the Company has entered into agreements with C. Jack Bean, Chairman of the Board, G. M. Heinzelmann, III, President, and Bobby W. Hackler, Vice President, providing that, if there is a change in control of the Company and any or all of such employees are terminated as employees of the Company or are materially relieved of their duties, the Company will pay to such employee three times his annual base salary at the time of termination or relief from duties as a lump sum severance payment or the equivalent value in Common Stock of the Company based upon the prevailing market price for the Common Stock at the time of termination or relief from duties. A change in control of the Company for purposes of the agreements is (i) the acquisition of 20% or more of the Company's outstanding voting securities by any person or entity other than a fiduciary of an employee benefit plan of the Company, or (ii) a change in the persons constituting a majority of the Board of Directors over a two year period unless the election of each person who was not a director at the beginning of the two years was approved in advance by directors representing at least two-thirds of the directors then in office who were directors at the beginning of the period. In addition, the Company has entered into Executive Deferred Compensation Agreements with Messers. Hackler and Heinzelmann under which each is entitled to receive certain deferred compensation payments from the Company after age 65. If employment is terminated prior to age 65 due to a change in control, disability, death, or other than for cause, each officer will be entitled to a lump sum payment equal to the cash surrender value of a designated universal key man life insurance policy. The Company is not required to reserve or accrue funds to make such payments. CERTAIN TRANSACTIONS From time to time, the Bank makes loans to officers, directors and principal shareholders (and their affiliates) of the Company or the Bank. All loans to such persons are made in the ordinary course of business; are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons; and do not involve more than the normal risk of collectibility or present other unfavorable features. INDEMNIFICATION OF DIRECTORS AND OFFICERS Section 145 of the General Corporation Law of the State of Delaware (the "Act") empowers a corporation to indemnify its directors and officers and to purchase insurance with respect to liability arising out of their capacity as directors and officers. The Act further provides that the indemnification permitted thereunder shall not be deemed exclusive of any other rights to which the directors and officers may be entitled under the corporation's bylaws, any agreement, vote of the shareholders, or otherwise. Section 6.04 of the Company's Bylaws provides that the Company shall indemnify all persons to the full extent allowable by law who, by reason of the fact that they are or were a director of the Company, become a party or are threatened to be made a party to any indemnifiable action, suit or proceeding. The Company shall pay, in advance of the final disposition of any indemnifiable action, suit or proceeding under this bylaw, all reasonable expenses incurred by the director, upon receipt of an undertaking by or on behalf of the director to repay such amount if it is ultimately determined that he is not entitled to be indemnified by the Company under the law. The Company may indemnify persons other than directors, such as officers and employees, as permitted by law. The Company may purchase and maintain insurance on behalf of directors, officers and other persons against any liability asserted against him, whether or not the Company would have the power to indemnify such person against such liability, as permitted by law. 50 SELLING SHAREHOLDER The Selling Shareholder, Anchorage Fire & Casualty Insurance Company, in Liquidation, acting through Jeanne Barnes Bryant, Special Deputy Commissioner and Liquidator under the Liquidation Order dated May 13, 1993, issued by the Chancery Division of the Twentieth Judicial District Court, Davidson County, Tennessee ("Liquidation Order"), is offering an aggregate of 174,939 shares of Common Stock in the Offering, which constitutes all of the shares of Common Stock beneficially owned by the Selling Shareholder. The shares are being sold by the Selling Shareholder pursuant to the Liquidation Order, which required the liquidation of all assets of Anchorage Fire & Casualty Insurance Company. The 174,939 shares were acquired by Anchorage Fire & Casualty Insurance Company in December 1991 under a Regulation S offering of Common Stock of the Company. In December 1995, in order to eliminate the market overhang represented by these shares and to obtain the advantages of a larger public float, among other things, the Company and the Selling Shareholder agreed to include the Selling Shareholder's shares of Common Stock in this prospectus. The Registration Agreement provides that the Selling Shareholder will bear the underwriting discount applicable to the shares sold by it, as well as a pro rata share of the expenses and filing fees associated with this Offering. The Registration Agreement also provides that the Company and the Selling Shareholder will indemnify the Underwriter and each other from certain liabilities, including liabilities under the Securities Act of 1933, as amended. BENEFICIAL STOCK OWNERSHIP BY MANAGEMENT The following table shows beneficial ownership of shares of Common Stock of the Company by all current directors and executive officers of the Company named under the caption "Management" individually, and together with all current executive officers of the Company as a group, as of November 30, 1995:
AMOUNT AND NATURE OF BENEFICIAL PERCENT OF NAME OF INDIVIDUAL OR NUMBER OF PERSONS IN GROUP OWNERSHIP (1) CLASS (2) - -------------------------------------------------------------------------------- ------------------ ------------ C. Jack Bean.................................................................... 206,019 shares(3) 5.86% William B. Byrd................................................................. 5,800 shares * Bobby W. Hackler................................................................ 21,482 shares(4) * Joseph S. Hardin................................................................ 191,583 shares(5) 5.46% G. M. Heinzelmann, III.......................................................... 29,685 shares(6) * Michael L. Milam................................................................ 250 shares * Garrett Morris.................................................................. 250 shares * Cullen W. Turner................................................................ 60,300 shares(7) 1.72% All directors and executive officers as a group (8 persons)..................... 515,369 shares(8) 14.47%
- ------------------------ * Less than 1% of all the issued and outstanding shares of Common Stock. (1) Based on information furnished by persons named and, except as otherwise indicated below, each person has sole voting power with respect to all shares of Common Stock owned by such person. (2) Based on 3,506,429 shares of Common Stock issued and outstanding at November 30, 1995, as adjusted for shares convertible or exercisable within 60 days which are deemed outstanding for a specific shareholder pursuant to Rule 13d-3(d)(1) under the Securities Exchange Act of 1934, as amended. (3) Includes 206,019 shares of Common Stock owned of record and 11,900 shares of Common Stock which Mr. Bean has the right to acquire within 60 days from the date hereof pursuant to options granted to him under the 1988 Plan of the Company. See "Management -- Executive Compensation and Other Information -- Options Exercises and Holdings". 51 (4) Includes 128 shares of Common Stock owned of record and 21,354 shares of Common Stock which Mr. Hackler has the right to acquire within 60 days from the date hereof pursuant to options granted to him under the 1988 Plan of the Company. See "Management -- Executive Compensation and Other Information -- Options Exercises and Holdings". (5) Represents 191,583 shares of Common Stock held by a trust for which Mr. Hardin serves as a co-trustee. (6) Includes 7,725 shares of Common Stock owned of record and 21,960 shares of Common Stock which Mr. Heinzelmann has the right to acquire within 60 days from the date hereof pursuant to options granted to him under the 1988 Plan of the Company. See "Management -- Executive Compensation and Other Information -- Options Exercises and Holdings". (7) Includes 39,500 shares of Common Stock owned of record and 20,800 shares of Common Stock held by a trust for which Mr. Turner serves as trustee. (8) Includes 55,214 shares of Common Stock of the Company currently exercisable pursuant to the Company's 1988 Plan. BY OTHERS The following table sets forth certain information with respect to shareholders of the Company who were known to be beneficial owners of more than 5% of the issued and outstanding shares of the Common Stock of the Company as of November 30, 1995:
AMOUNT AND NATURE PERCENT OF BENEFICIAL OF CLASS NAME AND ADDRESS OF BENEFICIAL OWNER OWNERSHIP (1) (2) - --------------------------------------------- ------------------ --------- C. Jack Bean & the Estate of Lorene Sims Bean 206,019 shares(3) 5.86% 1845 Precinct Line Road, #100 Hurst, Texas 76054 Joseph S. Hardin 191,583 shares(4) 5.46% 5310 Tanbark Road Dallas, Texas 75229 John Hancock Bank & Thrift 303,700 shares 8.66% Opportunity Fund c/o State Street Bank 61 Broadway New York, New York 10009 Evergreen Limited Market Fund, Inc. 346,000 shares 9.87% c/o Lieber & Company 2500 Westchester Avenue Purchase, NY 10577
- ------------------------ (1) Based on information furnished by persons and entities named and, except as otherwise indicated below, each person and entity has sole voting power with respect to all shares of Common Stock owned by such person or entity. (2) Based on 3,506,429 shares of Common Stock issued and outstanding at November 30, 1995, as adjusted for shares convertible or exercisable within sixty (60) days which are deemed outstanding for a specific shareholder pursuant to Rule 13d-3(d)(1) under the Securities Exchange Act of 1934. (3) Includes 206,019 shares of Common Stock owned of record and 11,900 shares of Common Stock which Mr. Bean has the right to acquire within 60 days from the date hereof pursuant to options granted to him under the 1988 Plan of the Company. See "Management -- Executive Compensation and Other Information -- Options Exercises and Holdings". (4) Represents 191,583 shares of Common Stock held by a trust for which Mr. Hardin serves as a co-trustee. 52 DESCRIPTION OF SECURITIES COMMON STOCK The Company is authorized to issue twenty million (20,000,000) shares of Common Stock, par value $0.01 per share, 3,506,429 of which shares were issued and outstanding as of November 30, 1995 (not including 55,216 shares issuable upon the exercise of outstanding stock options). Holders of shares are entitled to one vote per share, without cumulative voting, on all matters to be voted on by shareholders. Therefore, the holders of a majority of the shares voting for the election of directors can elect all the directors without the concurrence of any other shareholder. Subject to preferences that may be applicable to any outstanding preferred stock, shareholders are entitled to receive ratably such dividends as may be declared by the Board of Directors out of funds legally available. See "Market Price and Dividend Policy". In the event of a liquidation, dissolution or winding up of the Company, shareholders are entitled to share ratably in all assets remaining after payment of liabilities and the liquidation preference of any outstanding preferred stock. Shares of the Common Stock have no preemptive or other subscription rights, and there are no conversion rights or redemption or sinking fund provisions with respect to such shares. The transfer agent and registrar of the common stock is Securities Transfer Corporation, 16910 Dallas Parkway, Suite 100, Dallas, Texas 75248. PREFERRED STOCK The Company is authorized to issue one million (1,000,000) shares of preferred stock, par value $0.01 per share, none of which are issued and outstanding as of the date of this Prospectus. The Board of Directors of the Company may establish series of preferred stock with such rights and preferences as may be fixed and determined by the Board of Directors. UNDERWRITING Subject to the terms and conditions of the Underwriting Agreement among the Company, the Selling Shareholder, and the Underwriter, the Underwriter has agreed to purchase from the Company and the Selling Shareholder, and the Company and the Selling Shareholder have agreed to sell to the Underwriter, 1,925,061 and 174,939 shares of Common Stock, respectively. The Underwriting Agreement provides that the obligations of the Underwriter thereunder are subject to the satisfaction of certain conditions precedent. The Underwriter is committed to purchase and pay for all 2,100,000 shares of Common Stock if any are purchased. The Company has been advised that the Underwriter proposes to offer the shares of Common Stock directly to the public at the public offering price set forth on the cover page of this prospectus, and to certain securities dealers at such price less a concession not in excess of $ per share, and that the Underwriter and such dealers may reallow to other dealers including any underwriter, a discount not in excess of $ per share. After commencement of this Offering, the offering price and concession and discounts may be changed by the Underwriter. The Company has agreed to pay the Underwriter an accountable expense allowance not to exceed 2% of the aggregate offering price. The Underwriter has obtained an option from the Company exercisable during a 30-day period after the date of this prospectus, under which the Underwriter may purchase up to 288,759 additional shares of Common Stock at the same price per share which the Company will receive for the shares offered herein. The Underwriter may exercise such option only once to cover over-allotments. The Company and its executive officers and directors have agreed that they will not sell, contract to sell or otherwise dispose of any equity securities of the Company for a period of 180 days after the date of this prospectus without the written consent of the Underwriter. The Company and the Selling Shareholder have agreed to indemnify the Underwriter against certain liabilities, losses and expenses, including liabilities under the Securities Act, or to contribute to payments that the Underwriter may be required to make in respect thereof. 53 LEGAL MATTERS Certain matters with respect to the validity of the shares have been passed upon by Secore & Waller, L.L.P., Dallas, Texas. Certain legal matters will be passed upon for the Underwriter by Bracewell & Patterson, L.L.P., Houston, Texas. EXPERTS The consolidated financial statements of the Company as of December 31, 1994 and 1993 and the related consolidated Statements of Operations, Shareholders' Equity, and Cash Flows for each of the three years in the period ended December 31, 1994, included in this prospectus and elsewhere in the Registration Statement, have been included herein in reliance on the report of Coopers & Lybrand, L.L.P. independent accountants, given on the authority of that firm as experts in accounting and auditing. The consolidated financial statements of the First Midlothian Corporation, Midlothian, Texas as of December 31, 1994 and for each of the two years in the period ended December 31, 1994, and as of September 30, 1995 and for the period then ended, also included in this prospectus and elsewhere in the Registration Statement have been included herein in reliance on the report of Samson, Robbins & Associates P.L.L.C., independent accountants, given on the authority of that firm as experts in accounting and auditing. AVAILABLE INFORMATION The Company has filed a Registration Statement on Form S-1 under the Securities Act of 1933, as amended, with the Securities and Exchange Commission (the "Commission") with respect to the Common Stock offered pursuant to this prospectus. This prospectus, which forms a part of the Registration Statement, does not contain all of the information included in the Registration Statement and the exhibits thereto. In addition, the Company is subject to the informational requirements of the Securities Exchange Act of 1934 and in accordance therewith files reports and other information with the Commission. The Registration Statement filed with respect to this prospectus, and all other Company reports, proxy statements and other information can be inspected free of charge at the offices of the Commission at Room 1024, 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549; and at 411 W. Seventh Street, Eighth Floor, Fort Worth, Texas 76102. Copies of such material may be obtained upon the payment of prescribed rates from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549. The Company's common stock is traded on the AMEX and copies of the Company's periodic reports, proxy statements, and other information is also available for inspection at the AMEX at 86 Trinity Place, Fifth Floor Library, New York, NY 10006. The telephone number at the AMEX is (212) 306-1290. 54 INDEX TO FINANCIAL STATEMENTS
PAGE --------- Surety Capital Corporation: Report of Independent Accountants........................................................................ F-2 Consolidated Balance Sheets as of December 31, 1994, 1993 and September 30, 1995 (unaudited)............. F-3 Consolidated Statements of Income for the years ended December 31, 1994, 1993 and 1992 and the nine months ended September 30, 1995 (unaudited) and 1994 (unaudited)........................................ F-4 Consolidated Statements of Shareholders' Equity.......................................................... F-5 Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992 and the nine months ended September 30, 1995 (unaudited) and 1994 (unaudited)........................................ F-6 Notes to Consolidated Financial Statements............................................................... F-7 First Midlothian Corporation: Report of Independent Accountants........................................................................ F-24 Consolidated Balance Sheets as of September 30, 1995 and December 31, 1994............................... F-25 Consolidated Statements of Income for the nine months ended September 30, 1995 and the years ended December 31, 1994 and 1993.............................................................................. F-26 Consolidated Statements of Shareholders' Equity as of December 31, 1992, 1993, 1994 and September 30, 1995.................................................................................................... F-27 Consolidated Statements of Cash Flows for the nine months ended September 30, 1995 and the years ended December 31, 1994 and 1993.............................................................................. F-28 Notes to Consolidated Financial Statements............................................................... F-29
F-1 REPORT OF INDEPENDENT ACCOUNTANTS Board of Directors and Shareholders Surety Capital Corporation Fort Worth, Texas We have audited the accompanying consolidated balance sheets of Surety Capital Corporation as of December 31, 1994 and 1993, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Surety Capital Corporation as of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. As discussed in Note 1 to the financial statements, Surety Capital Corporation changed its method of accounting for investment securities and income taxes in 1994 and 1993, respectively. COOPERS & LYBRAND LLP Fort Worth, Texas January 27, 1995, except as to the information presented in Note 7, for which the date is March 8, 1995 F-2 SURETY CAPITAL CORPORATION CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 1995, DECEMBER 31, 1994 AND 1993 ASSETS
SEPTEMBER 30, DECEMBER 31, DECEMBER 31, 1995 1994 1993 ------------- ------------ ------------ (UNAUDITED) Assets: Cash and due from banks....................................................... $ 4,997,517 $ 3,929,360 $ 2,436,487 Federal funds sold............................................................ 21,660,000 7,265,000 4,450,000 ------------- ------------ ------------ Cash and cash equivalents................................................... 26,657,517 11,194,360 6,886,487 Interest bearing deposits in financial institutions........................... 1,334,860 1,524,188 648,000 Investment securities......................................................... 17,017,258 19,504,254 8,218,029 Net loans..................................................................... 67,923,543 63,965,402 31,225,035 Premises and equipment, net................................................... 2,776,443 2,393,601 1,304,845 Accrued interest receivable................................................... 622,518 623,737 161,470 Other real estate and repossessed assets...................................... 92,830 121,359 34,676 Other assets.................................................................. 594,762 451,891 115,128 Excess of cost over fair value of net assets acquired, net of accumulated amortization of $312,411, $175,240 and $124,039 at September 30, 1995, and December 31, 1994 and 1993, respectively..................................... 2,534,050 2,515,519 442,588 ------------- ------------ ------------ Total assets................................................................ $ 119,553,781 $102,294,311 $ 49,036,258 ------------- ------------ ------------ ------------- ------------ ------------ LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Demand deposits............................................................... $ 13,914,468 $ 12,191,183 $ 7,311,674 Savings, NOW and money markets................................................ 31,421,332 29,875,481 17,040,843 Time deposits, $100,000 and over.............................................. 13,885,925 7,942,882 5,639,734 Other time deposits........................................................... 48,986,950 42,017,576 13,603,668 ------------- ------------ ------------ Total deposits.............................................................. 108,208,675 92,027,122 43,595,919 Note payable.................................................................. 375,000 1,750,000 -- Federal income tax payable.................................................... 254,386 -- -- Accrued interest payable and other liabilities................................ 679,019 451,508 159,351 ------------- ------------ ------------ Total liabilities........................................................... 109,517,080 94,228,630 43,755,270 ------------- ------------ ------------ Commitments and contingent liabilities (Notes 9 & 14) Shareholders' equity: Common stock, $.01 par value, 20,000,000 shares authorized, 3,516,595, 3,040,829 and 2,273,487 shares issued and outstanding at September 30, 1995, December 31, 1994 and 1995, respectively..................................... 35,166 30,408 22,734 Additional paid-in capital.................................................... 9,364,515 8,113,214 5,806,116 Retained earnings/(deficit)................................................... 573,311 (75,102) (547,862) Treasury stock, 10,166 shares carried at cost................................. (50,830) -- -- Unrealized gain/(loss) on available-for-sale securities....................... 114,539 (2,839) -- ------------- ------------ ------------ Total shareholders' equity.................................................... 10,036,701 8,065,681 5,280,988 ------------- ------------ ------------ Total liabilities and shareholders' equity.................................... $ 119,553,781 $102,294,311 $ 49,036,258 ------------- ------------ ------------ ------------- ------------ ------------
The accompanying notes are an integral part of the consolidated financial statements. F-3 SURETY CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1994 (UNAUDITED) AND THE TWELVE MONTHS ENDED DECEMBER 31, 1994, 1993 AND 1992
SEPTEMBER 30, SEPTEMBER 30, 1995 1994 1994 1993 1992 ------------- ------------- ------------ ------------ ------------ Interest income: Commercial and real estate loans....... $ 2,759,887 $ 898,537 $ 1,422,911 $ 1,034,793 $ 774,203 Consumer loans......................... 861,646 768,043 1,059,188 966,458 858,543 Insurance premium financing............ 2,080,915 1,597,634 2,172,038 1,302,854 1,471,226 Federal funds sold..................... 358,600 188,197 302,621 162,830 222,146 Investment securities and interest bearing deposits...................... 810,719 290,620 430,251 528,126 17,455 Other interest income.................. -- -- -- -- 395 ------------- ------------- ------------ ------------ ------------ Total interest income................ 6,871,767 3,743,031 5,387,009 3,995,061 3,343,968 ------------- ------------- ------------ ------------ ------------ Interest expense: Savings, NOW and money market................................ 569,783 305,732 353,123 306,899 240,057 Time deposits, $100,000 and over....... 579,022 206,173 362,700 198,151 207,547 Other time deposits.................... 1,276,222 459,659 760,833 618,534 530,111 Other interest expense................. 111,915 -- 11,075 -- -- ------------- ------------- ------------ ------------ ------------ Total interest expense............... 2,536,942 971,564 1,487,731 1,123,584 977,715 ------------- ------------- ------------ ------------ ------------ Net interest income before provision for loan losses......... 4,334,825 2,771,467 3,899,278 2,871,477 2,366,253 Provision for loan losses................ 60,000 66,898 106,899 90,584 299,555 ------------- ------------- ------------ ------------ ------------ Net interest income.................. 4,274,825 2,704,569 3,792,379 2,780,893 2,066,698 ------------- ------------- ------------ ------------ ------------ Noninterest income....................... 1,056,095 800,805 1,160,007 1,181,808 784,066 ------------- ------------- ------------ ------------ ------------ Noninterest expense: Salaries and employee benefits......... 2,143,694 1,577,591 2,201,188 1,715,952 1,194,179 Occupancy and equipment................ 668,483 473,588 669,936 495,055 411,587 General and administrative............. 1,569,753 1,152,961 1,590,814 1,380,971 1,228,574 ------------- ------------- ------------ ------------ ------------ Total noninterest expense............ 4,381,930 3,204,140 4,461,938 3,591,978 2,834,340 ------------- ------------- ------------ ------------ ------------ Income before income taxes......... 948,990 301,234 490,448 370,723 16,424 Income tax expenses: Current................................ 300,577 7,500 36,697 Deferred............................... (19,009) ------------- ------------- ------------ ------------ ------------ Net income........................... $ 648,413 $ 293,734 $ 472,760 $ 370,723 $ 16,424 ------------- ------------- ------------ ------------ ------------ ------------- ------------- ------------ ------------ ------------ Net income per share of common stock..... $.20 $.13 $.20 $.19 $.00 ------------- ------------- ------------ ------------ ------------ ------------- ------------- ------------ ------------ ------------ Weighted average shares outstanding............................. 3,208,319 2,344,491 2,393,841 2,001,689 1,951,873 ------------- ------------- ------------ ------------ ------------ ------------- ------------- ------------ ------------ ------------
The accompanying notes are an integral part of the consolidated financial statements. F-4 SURETY CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 AND THE NINE MONTHS ENDED SEPTEMBER 30, 1995 (UNAUDITED)
UNREALIZED GAIN/ ACCUMULATED (LOSS) ON COMMON STOCK ADDITIONAL RETAINED AVAILABLE- --------------------- PAID-IN EARNINGS/ TREASURY FOR-SALE SHARES PAR VALUE CAPITAL (DEFICIT) STOCK SECURITIES TOTAL EQUITY ---------- --------- ----------- ------------ --------- ---------- ------------ Balance at December 31, 1991....... 1,767,062 $ 17,670 $ 4,180,134 $ (935,009) -- -- $ 3,262,795 Sale of common stock............... 214,385 2,144 776,999 779,143 Net income......................... 16,424 16,424 ---------- --------- ----------- ------------ --------- ---------- ------------ Balance at December 31, 1992....... 1,981,447 19,814 4,957,133 (918,585) -- -- 4,058,362 Sale of common stock............... 292,040 2,920 848,983 851,903 Net income......................... 370,723 370,723 ---------- --------- ----------- ------------ --------- ---------- ------------ Balance at December 31, 1993....... 2,273,487 22,734 5,806,116 (547,862) -- -- 5,280,988 Sale of Common Stock............... 767,342 7,674 2,307,098 2,314,772 Net Income......................... 472,760 472,760 Unrealized loss on available-for- sale securities, net of income taxes............................. $ (2,839) (2,839) ---------- --------- ----------- ------------ --------- ---------- ------------ Balance at December 31, 1994....... 3,040,829 30,408 8,113,214 (75,102) -- (2,839) 8,065,681 ---------- --------- ----------- ------------ --------- ---------- ------------ Sale of Common Stock............... 475,766 4,758 1,251,301 1,256,059 Purchase of Treasury Stock......... (50,830) (50,830) Net Income......................... 648,413 648,413 Unrealized gain on available- for-sale securities, net of income taxes............................. 117,378 117,378 ---------- --------- ----------- ------------ --------- ---------- ------------ Balance at September 30, 1995 (unaudited)....................... 3,516,595 $ 35,166 $ 9,364,515 $ 573,311 $ (50,830) $ 114,539 $ 10,036,701 ---------- --------- ----------- ------------ --------- ---------- ------------ ---------- --------- ----------- ------------ --------- ---------- ------------
The accompanying notes are an integral part of the consolidated financial statements. F-5 SURETY CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1994 (UNAUDITED) AND FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30, ---------------------------------------- 1995 1994 1994 1993 1992 ------------- ------------- ------------ ------------ ------------ (UNAUDITED) (UNAUDITED) Cash flows from operating activities: Net income........................................... $ 648,413 $ 293,734 $ 472,760 $ 370,723 $ 16,424 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses.......................... 60,000 66,898 106,899 90,584 299,555 Depreciation and amortization...................... 433,373 286,398 381,845 247,501 230,532 Gain (loss) on sale or disposal of assets.......... 100 (15,508) (99,049) (5,587) Net change in other assets......................... (639,798) (293,047) (217,868) 216,152 (41,185) Net increase/(decrease) in accrued interest payable and other liabilities............................. 996,211 (38,312) (125,277) (2,424) (213,945) ------------- ------------- ------------ ------------ ------------ Net cash provided by operating activities........ 1,498,299 315,671 602,851 823,487 285,794 ------------- ------------- ------------ ------------ ------------ Cash flows from investing activities: Proceeds from the sale of available-for-sale securities.......................................... 4,736,538 Proceeds from the sale of held-to-maturity securities.......................................... 500,000 500,000 6,084,844 Proceeds from the maturity of held-to-maturity securities and interest bearing liabilities......... 2,716,665 4,885,510 5,269,724 2,799,980 Proceeds from the maturity of available-for-sale securities.......................................... 2,664,997 169,971 Purchase of premises and equipment................... (460,784) (351,371) (420,487) (560,529) (156,906) Net increase in loans................................ (2,534,748) (7,506,927) (7,624,058) (8,448,392) (401,553) Proceeds from sale of assets......................... 16,308 Purchase of available-for-sale securities............ (3,954,573) Purchase of held-to-maturity securities.............. (3,487,203) (94,429) (316,276) Purchase of investment securities.................... (3,532,926) (543,500) Payments received on purchased medical claims receivable.......................................... 12,961,663 9,195,279 12,290,141 11,585,316 11,120,480 Purchase of medical claims receivable................ (13,569,897) (7,249,097) (11,229,044) (12,564,026) (11,299,682) Direct cost incurred for bank acquisition............ (115,039) (71,935) Net cash acquired through purchase of bank........... 15,418,983 7,485,325 2,624,200 1,441,254 ------------- ------------- ------------ ------------ ------------ Net cash provided by (used in) investing activities........................................ 14,491,641 6,864,290 1,165,440 (3,194,479) (1,280,570) ------------- ------------- ------------ ------------ ------------ Cash flows from financing activities: Net change in deposits............................... (357,012) (1,602,783) (1,525,190) Payments on borrowings of note payable............... (1,375,000) Purchase of treasury stock........................... (50,830) Proceeds from the sale of common stock............... 1,256,059 394,713 2,314,772 851,903 779,143 Proceeds from borrowings on note payable............. 1,750,000 ------------- ------------- ------------ ------------ ------------ Net cash provided by (used in) financing activities........................................ (526,783) (1,208,070) 2,539,582 (446,731) 4,284,513 ------------- ------------- ------------ ------------ ------------ Net increase in cash................................... 15,463,157 5,971,891 4,307,873 (2,817,723) 3,289,737 Beginning cash and cash equivalents.................... 11,194,360 6,886,487 6,886,487 9,704,210 6,414,473 ------------- ------------- ------------ ------------ ------------ Ending cash and cash equivalents....................... $26,657,517 $12,858,378 $ 11,194,360 $ 6,886,487 $ 9,704,210 ------------- ------------- ------------ ------------ ------------ ------------- ------------- ------------ ------------ ------------ Supplemental disclosure: Cash paid during the period for interest............. $ 2,433,146 $ 951,084 $ 1,339,223 $ 1,074,507 $ 1,021,014 Cash paid during the period for federal income taxes............................................... $ 18,608 $ 7,500 $ 12,000 -- --
The accompanying notes are an integral part of the consolidted financial statements. F-6 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION: The accompanying consolidated financial statements include the accounts of the Company and its subsidiary, Surety Bank, National Association, ("Bank"), which is 99% owned and was acquired on December 30, 1989. All significant intercompany accounts and transactions have been eliminated in consolidation. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are sold for one day periods. INVESTMENT SECURITIES Effective January 1, 1994, the Company adopted STATEMENT OF FINANCIAL ACCOUNTING STANDARDS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). This statement addresses the accounting and reporting for investments in equity securities that have readily determined fair values for all investments in debt securities. Management determines the appropriate classification of securities at the time of purchase. If the securities are purchased with the positive intent and the ability to hold the securities until maturity, they are classified as held-to-maturity and carried at historical cost, adjusted for amortization of premiums and accretion of fees and discounts using a method that approximates the interest method. Securities to be held for indefinite periods of time are classified as available-for-sale and carried at fair value. Securities purchased and held principally for the purpose of selling them in the near term are classified as trading. The Company has no securities classified as trading as of December 31, 1994. The cost of securities sold is based on the specific identification method. The effect at September 30, 1995 was an increase in stockholders' equity of $117,378 (net of $56,219 of deferred income tax) to reflect the net unrealized holding gain on available-for-sale securities. The effect at December 31, 1994 was a decrease in stockholders' equity of $2,839 (net of $1,462 of deferred income tax) to reflect the net unrealized holding loss on available-for-sale securities. The available-for-sale classification includes securities which were acquired through the acquisition of the First National Bank of Whitesboro, which were marked to market as of the acquisition date at December 8, 1994. LOANS AND ALLOWANCE FOR LOAN LOSSES Loans are stated at the amount of unpaid principal, reduced by unearned interest and an allowance for loan losses. The allowance for loan losses is established through a provision for loan losses charged against current earnings. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance for loan losses is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible, based upon evaluation of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay. Interest income on insurance premium financing loans and installment loans is recognized by a method which approximates the interest method. Interest income on commercial and real estate loans is accrued daily on the amount of outstanding principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that a borrower's financial condition is such that collection of interest and principal is doubtful. Management evaluates the book value (including accrued interest) and collateral value on loans placed on nonaccrual status and provides specific allowance for loan losses as deemed appropriate. F-7 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) Certain fees and costs associated with the origination of loans are deferred and recognized over the estimated lives of the related loans as an adjustment to yield. PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method at rates sufficient to amortize the cost over the estimated lives of the assets. Expenditures for repairs and maintenance are expensed as incurred, and renewals and betterments that extend the lives of assets are capitalized. Cost and accumulated depreciation are eliminated from the accounts when assets are sold or retired and any resulting gain or loss is reflected in operations in the year of disposition. OTHER REAL ESTATE AND REPOSSESSED ASSETS Foreclosed real estate and other assets are recorded at the lower of the unpaid balance of the related loan or the fair market value of the property. Any write down to fair market value at the date of acquisition is charged against the allowance for loan losses. Any subsequent write downs are reflected in operations. INCOME PER SHARE Net income per share of common stock is computed based upon the weighted average number of shares of common stock outstanding during the nine months ended September 30, 1995 and 1994 and the years ended December 31, 1994, 1993 and 1992. INCOME TAXES During 1993, the Company adopted STATEMENT OF ACCOUNTING STANDARDS (SAS) No. 109 whereby the method of accounting for income taxes utilized an asset and liability approach for financial statement purposes. Under SFAS No. 109, the types of differences between the tax bases of assets and liabilities and their financial reporting amounts that give rise to significant portions of deferred income tax liabilities or assets include: allowances for possible loan losses, property and equipment, investment securities and net operating loss carryforwards. The change in accounting did not have an effect on the Company's consolidated financial position or results of operations. PURCHASE METHOD OF ACCOUNTING Net assets acquired in purchase transactions are recorded at their fair value at the date of acquisition. The excess of purchase price over fair value of net assets acquired is amortized on a straight-line basis generally over a 15-year period. The Company continually re-evaluates the propriety of the carrying amount of such intangible assets, as well as their amortization period, to determine whether current events and circumstances warrant adjustments to the carrying value and/or revised estimates of the period of benefit. At this time, the Company believes that no significant impairment of such intangible assets has occurred and that no reduction of amortization period is warranted. RECLASSIFICATIONS Certain balances for the year ended December 31, 1994 and 1993 have been reclassified to conform to the presentation adopted for the nine months ended September 30, 1995. These reclassifications had no effect on net income, total assets, total liabilities, or shareholders' equity as previously reported. RECENT ACCOUNTING PRONOUNCEMENTS In March 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This Statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances F-8 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) indicate that the carrying amount of an asset may not be recoverable. Measurement of an impairment loss for long-lived assets and identifiable intangibles that an entity expects to hold and use should be based on the fair value of the asset. This Statement is effective for fiscal years beginning after December 15, 1995. In October 1995, the FASB issued Statement of Accounting Standards No. 123, "Accounting for Stock-Based Compensation." This Statement defines a fair value based method of accounting for an employee stock option or similar equity instrument and encourages all entities to adopt that method of accounting for all employee stock compensation plans. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees. Entities electing to remain with the accounting method specified in Opinion 25 must make pro forma disclosures of net income and, if presented, earnings per share, as if the fair value method of accounting defined in this Statement had been applied. This Statement is effective for fiscal years beginning after December 15, 1995. In November 1995, the FASB issued a Financial Accounting Series Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." The FASB concluded that concurrent with the initial adoption of this implementation guidance, but no latter than December 15, 1995, an enterprise may reassess the appropriateness of the classification of all securities held at that time and account for any resulting reclassifications at fair value and such reclassifications should be disclosed in accordance with the provisions of Statement 115. Management believes that the adoption of these pronouncements will not have a material impact on the financial statements of the Company. 3. ACQUISITIONS: FIRST NATIONAL BANK, WHITESBORO, TEXAS On May 24, 1994, Surety Bank entered into an agreement for the acquisition of First National Bank, a national banking association located in Whitesboro, Texas. The acquisition was effected through the merger of First National Bank with and into Surety Bank effective as of the close of business on December 8, 1994. Pursuant to the merger, Surety Bank paid $6,000,000 to the shareholders of First National Bank in exchange for all of the issued and outstanding shares of common stock of First National Bank. The purchase price of $30.00 per share was based on approximately 150% of the book value of First National Bank as of December 31, 1993. As a result of the earnings of First National Bank during the fiscal year 1994, the purchase price of $30.00 per share represented approximately 130% of the book value of First National Bank as of the date of consummation of the merger. In connection with the merger, Surety Bank purchased all of the assets and assumed all of the obligations of First National Bank. To finance the merger, Surety Bank received a $4,000,000 capital contribution from the Company. The Company raised $2,169,050 under a limited offering of its shares of common stock, pursuant to which it sold 667,400 shares of common stock at $3.25 per share and the Company obtained a $1,750,000, 90-day note payable to Overton Bank and Trust, N.A. After the note matured on June 7, 1995, the Company reduced the balance of the note to $500,000 and a new note was obtained for the remaining balance with a maturity of January 23, 1996. As of September 30, 1995, the note bore an interest at eleven and one-half percent (11.50%), had a balance of $375,000, and provided for quarterly interest payments and one principal payment at maturity. The acquisition has been accounted for as a purchase in the accompanying consolidated financial statements and the assets and liabilities of First National Bank were recorded at their fair values as of November 30, 1994. F-9 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. ACQUISITIONS: (CONTINUED) Included in the accompanying unaudited consolidated financial statements are the following amounts for First National Bank as of September 30, 1995 and for the nine months ended September 30, 1995: Balance sheet data: Cash and due from banks.............................. $ 509,620 Federal funds sold................................... 4,310,000 Investment securities................................ 4,764,782 Net loans............................................ 22,225,087 Premises and equipment, net.......................... 836,314 Accrued interest receivable.......................... 290,723 Other assets......................................... 241,827 ---------- Total assets......................................... $33,178,353 ---------- ---------- Income statement data: Total interest income................................ $1,826,948 Total interest expense............................... 947,017 Other income......................................... 231,661 Noninterest expense.................................. 756,667 ---------- Net income........................................... $ 354,925 ---------- ----------
The consolidated results of operations include the operations of First National Bank subsequent to December 1, 1994. The unaudited information for the nine months ended September 30, 1995 and the unaudited pro forma information for the nine months ended September 30, 1994, presented below, reflect the acquisition of First National Bank, as if it had been acquired as of January 1, 1994. Pro forma adjustments consisting of a provision for income taxes and interest expense have been made to reflect the unaudited pro forma information. Interest expense on short-term debt of $1,750,000 is included as if the short-term debt had been incurred on January 1, 1994.
NINE MONTHS NINE MONTHS ENDED ENDED SEPTEMBER 30, SEPTEMBER 30, 1995 1994 ------------- ------------- Interest income..................................................................... $ 6,871,767 $ 5,931,128 Net income.......................................................................... 648,413 516,241 Net income per share of common stock................................................ $ 0.20 $ 0.17
BANK ONE, TEXAS, NATIONAL ASSOCIATION BRANCH IN WAXAHACHIE, TEXAS On June 16, 1995, Surety Bank entered into an agreement with Bank One, Texas, National Association ("Bank One") for the acquisition of certain assets (principally cash) and the assumption of certain liabilities (principally customer deposits) by Surety Bank relating to one branch of Bank One located in Waxahachie, Texas (the "Waxahachie Branch"). The acquisition was consummated on September 28, 1995. Surety Bank financed the acquisition through the use of internally-generated funds. At the closing, Surety Bank assumed deposits and other liabilities totaling approximately $16,642,000. In addition, Surety Bank acquired certain small business and consumer loans totaling approximately $875,000, certain real property, furniture and equipment related to the Waxahachie Branch totaling approximately $271,000, and cash and other assets totaling approximately $15,496,000. After paying a deposit premium of two percent (2%) on the deposits assumed totaling approximately $331,000, Surety Bank received approximately $15,419,000 in cash from Bank One as consideration for the net deposit liabilities assumed. The Waxahachie Branch and deposits acquired in the acquisition have been incorporated into Surety Bank's existing branch network. F-10 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. INVESTMENT SECURITIES: Investment securities consisted of the following at September 30, 1995 (unaudited) and December 31, 1994 and 1993: September 30, 1995 (Unaudited):
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES MARKET VALUE ------------- ----------- ----------- ------------- HELD-TO-MATURITY: U.S. Treasury............................................ $ 99,205 $ 77 $ 99,128 Obligations of other U.S. Government agencies and corporations............................................ 5,476,904 256 5,987 5,471,173 State and county municipals.............................. 4,735,574 $ 263,040 4,998,614 ------------- ----------- ----------- ------------- 10,311,683 263,296 6,064 10,568,915 ------------- ----------- ----------- ------------- AVAILABLE-FOR-SALE: U.S. Treasury............................................ 483,490 11,510 495,000 Obligations of other U.S. Government agencies and corporations............................................ 5,747,766 179,219 17,185 5,909,800 Federal Reserve Bank Stock............................... 280,850 280,850 Other investment securities.............................. 19,925 19,925 ------------- ----------- ----------- ------------- 6,532,031 190,729 17,185 6,705,575 ------------- ----------- ----------- ------------- $ 16,843,714 $ 454,025 $ 23,249 $ 17,274,490 ------------- ----------- ----------- ------------- ------------- ----------- ----------- ------------- December 31, 1994 GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES MARKET VALUE ------------- ----------- ----------- ------------- HELD-TO-MATURITY: U.S. Treasury............................................ $ 2,123,659 $ 19,105 $ 2,104,554 Obligations of other U.S. Government agencies and corporations............................................ 2,668,466 170,865 2,497,601 State and county municipals.............................. 4,748,920 4,748,920 ------------- ----------- ----------- ------------- 9,541,045 189,970 9,351,075 ------------- ----------- ----------- ------------- AVAILABLE-FOR-SALE: U.S. Treasury............................................ 1,964,627 4,854 1,959,773 Obligations of other U.S. Government agencies and corporations............................................ 7,702,108 $ 553 7,702,661 Federal Reserve Bank stock............................... 280,850 280,850 Other investment securities.............................. 19,925 19,925 ------------- ----------- ----------- ------------- 9,967,510 553 4,854 9,963,209 ------------- ----------- ----------- ------------- $ 19,508,555 $ 553 $ 194,824 $ 19,314,284 ------------- ----------- ----------- ------------- ------------- ----------- ----------- -------------
F-11 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. INVESTMENT SECURITIES: (CONTINUED) December 31, 1993:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES MARKET VALUE ------------- ----------- ----------- ------------- U.S. Treasury.............................................. $ 2,085,555 $ 10,345 $ 2,095,900 Obligations of other U.S. Government agencies and corporations.............................................. 6,023,774 21,537 $ 23,196 6,022,115 Federal Reserve Bank stock................................. 108,700 108,700 ------------- ----------- ----------- ------------- $ 8,218,029 $ 31,882 $ 23,196 $ 8,226,715 ------------- ----------- ----------- ------------- ------------- ----------- ----------- -------------
The amortized cost and estimated market value of investment securities at September 30, 1995 (unaudited) and December 31, 1994 by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. September 30, 1995 (unaudited)
AMORTIZED ESTIMATED COST MARKET VALUE ------------- ------------- HELD-TO-MATURITY: Due within one year.............................................................. $ 1,232,093 $ 1,235,728 Due after one year through five years............................................ 5,085,377 5,163,506 Due after five years through ten years........................................... 3,482,659 3,664,114 Mortgage-backed securities....................................................... 511,554 505,567 ------------- ------------- Total.......................................................................... $ 10,311,683 $ 10,568,915 ------------- ------------- AVAILABLE-FOR-SALE: Due within one year.............................................................. $ 398,835 $ 401,703 Due after one year through five years............................................ 2,530,544 2,636,540 Due after five years through ten years........................................... 3,160,588 3,218,581 Mortgage-backed securities....................................................... 141,289 147,976 Other securities................................................................. 300,775 300,775 ------------- ------------- 6,532,031 6,705,575 ------------- ------------- Total.......................................................................... $ 16,843,714 $ 17,274,490 ------------- ------------- ------------- -------------
F-12 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. INVESTMENT SECURITIES: (CONTINUED) December 31, 1994
AMORTIZED ESTIMATED COST MARKET VALUE ------------- ------------- HELD-TO-MATURITY: Due within one year.............................................................. $ 3,144,762 $ 3,039,407 Due after one year through five years............................................ 2,606,346 2,606,346 Due after five years through ten years........................................... 2,121,471 2,121,471 Mortgage-backed securities....................................................... 1,668,466 1,583,851 ------------- ------------- 9,541,045 9,351,075 AVAILABLE-FOR-SALE: Due within one year.............................................................. 3,352,504 3,344,039 Due after one year through five years............................................ 4,475,799 4,482,206 Due after five years through ten years........................................... 1,520,328 1,522,789 Mortgage-backed securities....................................................... 318,104 313,400 Other securities................................................................. 300,775 300,775 ------------- ------------- 9,967,510 9,963,209 ------------- ------------- Total.......................................................................... $ 19,508,555 $ 19,314,284 ------------- ------------- ------------- -------------
Proceeds from sales of available-for-sale investment securities during the nine months ended September 30, 1995 were $4,736,538 with gross recognized gains of $100 and no losses. Proceeds from sales of held-to-maturity investment securities during the twelve months ended December 31, 1994 were $500,000 with no recognized gains or losses. These securities were sold within 90 days of the call date and were expected to be called. Proceeds from sales of investment securities during the twelve months ended December 31, 1993 were $6,084,844 with gross recognized gains and losses of $93,859 and $3,096, respectively. During the year ended December 31, 1992, there were no sales of investment securities. At September 30, 1995, December 31, 1994 and 1993 the carrying values of Federal Reserve Bank stock were $280,850, $280,050 and $108,700, respectively. The Federal Reserve Bank stock's market value was estimated to be the same as its carrying value at all dates. At September 30, 1995, December 31, 1994 and 1993, securities with a carrying amount of $12,871,040, $14,319,159 and $1,450,000, respectively, were pledged as collateral for public deposits, as required or permitted by law. F-13 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. NET LOANS: At September 30, 1995 and December 31, 1994 and 1993, the loan portfolio was composed of the following:
SEPTEMBER 30, DECEMBER 31, DECEMBER 31, 1995 1994 1993 ------------- ------------ ------------ (UNAUDITED) Insurance premium financing................................. $ 24,283,325 $ 20,931,642 $ 14,518,680 Commercial loans............................................ 15,590,320 13,205,698 5,204,120 Installment loans........................................... 11,519,839 12,029,243 1,878,030 Real estate loans........................................... 16,224,602 17,297,636 9,016,179 Medical claims receivable................................... 2,992,867 2,705,974 2,379,482 ------------- ------------ ------------ Total gross loans......................................... 70,610,953 66,170,193 32,996,491 Unearned interest........................................... (1,962,866) (1,506,843) (1,370,229) Allowance for loan losses................................... (724,544) (697,948) (401,227) ------------- ------------ ------------ Net loans................................................. $ 67,923,543 $ 63,965,402 $ 31,225,035 ------------- ------------ ------------ ------------- ------------ ------------
Activity in the allowance for loan losses for the nine months ended September 30, 1995 (unaudited) and for the years ended December 31, 1994, 1993 and 1992 were as follows:
SEPTEMBER DECEMBER DECEMBER DECEMBER 30, 1995 31, 1994 31, 1993 31, 1992 ----------- ----------- ----------- ----------- (UNAUDITED) Beginning balance................... $ 697,948 $ 401,227 $ 324,728 $ 343,206 Provision for loan losses........... 60,000 106,899 90,584 299,555 Bank acquisition.................... 10,181 340,832 71,976 Loans charged off................... (82,750) (212,266) (247,774) (672,313) Recoveries.......................... 39,165 61,256 161,713 354,280 ----------- ----------- ----------- ----------- Ending balance...................... $ 724,544 $ 697,948 $ 401,227 $ 324,728 ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Loans on which the accrual of interest has been discontinued amounted to approximately $27,000, $83,000 and $48,000 at September 30, 1995, December 31, 1994 and 1993, respectively. 6. PREMISES AND EQUIPMENT: Premises and equipment at September 30, 1995, December 31, 1994 and 1993 are summarized as follows:
SEPTEMBER 30, 1995 1994 1993 ------------- ---------- ---------- (UNAUDITED) Land........................................................ $ 215,116 $ 145,116 $ 88,616 Building.................................................... 1,383,819 1,183,960 495,040 Furniture, fixtures and computers........................... 2,073,093 1,666,434 1,189,832 Automobiles................................................. 226,788 225,282 142,851 Leasehold improvements...................................... 92,118 92,118 ------------- ---------- ---------- 3,990,934 3,312,910 1,916,339 Less accumulated depreciation............................... (1,214,491) (919,309) (611,494) ------------- ---------- ---------- Net premises and equipment.................................. $2,776,443 $2,393,601 $1,304,845 ------------- ---------- ---------- ------------- ---------- ----------
F-14 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. SHAREHOLDERS' EQUITY: During the nine months ended September 30, 1995, 459,500 shares of the Company's common stock were sold in an offering for a total consideration, net of expenses, of $1,256,059. During the twelve months ended December 31, 1994, 767,342 shares of the Company's common stock were sold in private placements for a total consideration, net of expenses, of $2,314,772. During the year ended December 31, 1993, 292,040 shares of the Company's common stock were sold in private placements for total consideration, net of expenses, of $851,903. During the year ended December 31, 1992, 214,385 shares of the Company's common stock were sold in private placements for total consideration, net of expenses, of $779,143. On April 22, 1993, the Company's Board of Directors approved a one-for-ten reverse split of the Company's common stock. The reverse split was approved by the shareholders of the Company on May 27, 1993. This action became effective on June 14, 1993 for shareholders of record as of June 11, 1993. A total of $178,331 was reclassified from par value of common stock to additional paid-in capital in connection with the reverse stock split. The par value of common stock remains unchanged. All per share amounts have been adjusted to reflect the reverse stock split on a retroactive basis. 8. STOCK OPTIONS AND WARRANTS: Under the Company's 1988 Incentive Stock Option Plan (the "1988 Plan"), up to 100,000 shares of the Company's common stock have been reserved for issuance to key employees pursuant to the exercise of incentive stock options granted to such key employees under the 1988 Plan. Options granted under the 1988 Plan vest immediately on the date of grant and have a term of five years, subject to earlier termination upon the occurrence of certain events related to termination of employment. All options granted under the 1988 Plan were granted at 100% to 110% of fair market value. No additional options may be granted under the 1988 Plan.
SHARES UNDER OPTION PRICE PER SHARE --------- ---------------- Outstanding at December 31, 1991........................................... 25,895 $2.34 to $6.53 Granted during 1992........................................................ 9,096 $6.56 to $7.22 Exercised during 1992...................................................... (16,438) $2.58 to $6.53 Canceled during 1992....................................................... -- --------- Outstanding at December 31, 1992........................................... 18,553 $2.34 to $6.53 Granted during 1993........................................................ 10,000 $5.00 to $5.50 Exercised during 1993...................................................... -- Canceled during 1993....................................................... (1,840) $5.94 --------- Outstanding at December 31, 1993........................................... 26,713 $2.34 to $7.22 Granted during 1994........................................................ 10,000 $4.50 to $4.95 Exercised during 1994...................................................... -- Canceled during 1994....................................................... (5,000) $3.44 to $5.47 --------- Outstanding at December 31, 1994........................................... 31,713 $2.34 to $7.22 Granted during 1995........................................................ 39,769 $3.13 Exercised during 1995...................................................... (16,266) $3.13 Canceled during 1995....................................................... -- --------- Outstanding at September 30, 1995.......................................... 55,216 $2.34 to $7.22
On February 21, 1995 the Board of Directors of the Company adopted the 1995 Incentive Stock Option Plan (the "1995 Plan"), pursuant to which up to 100,000 shares of the Company's common stock have been reserved for issuance to key employees pursuant to the exercise of incentive stock options granted to such key employees under the 1995 Plan. The 1995 Plan was approved by the shareholders of the Company on F-15 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. STOCK OPTIONS AND WARRANTS: (CONTINUED) April 28, 1995. Options granted under the 1995 Plan vest on the date of grant and have a term of ten years, subject to earlier termination upon the occurrence of certain events related to termination of employment. As of September 30, 1995 no options have been granted under the 1995 Plan. On April 1, 1994, the Company issued 4 warrants for the purchase of 355,000 shares of Surety Capital Corporation common stock at an exercise price of $4.50 per share. These warrants expired on March 31, 1995. These warrants were issued in connection with the private placement completed in 1993. On June 17, 1994, the Company issued 1 warrant for the purchase of 35,500 shares of Surety Capital Corporation common stock at an exercise price of $4.50 per share. This warrant expired on June 16, 1995. This warrant was issued in connection with the private placement completed in 1993. As of September 30, 1995, there were no warrants outstanding. 9. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATION OF CREDIT RISK: The Company's subsidiary Bank is party to financial instruments with off-balance-sheet risk, entered into in the normal course of business to meet the financing needs of its customers. These financial instruments include loan commitments and letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. The subsidiary Bank's exposure to credit loss in the event of nonperformance by counterparties to loan commitments and letters of credit is represented by the contractual amount of those instruments. The subsidiary Bank uses the same credit policies in making commitments and conditional obligations as are used in underwriting on-balance sheet instruments. The total amounts of financial instruments with off-balance sheet risk at September 30, 1995, December 31, 1994 and 1993 are as follows:
DECEMBER 31, SEPTEMBER 30, -------------------- 1995 1994 1993 ------------- ---------- -------- (UNAUDITED) Unfunded loan commitments....................................................... $2,087,000 $1,833,000 $944,000 Letters of credit............................................................... 361,000 182,000 105,000 Credit card lines............................................................... -- 339,000 404,000
Since many of the loan commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Loans are made in accordance with formal written loan policies. The subsidiary Bank evaluates each customer's credit worthiness on a case by case basis. The amount of collateral obtained, if deemed necessary by the subsidiary Bank, upon extension of credit is based on management's evaluation of the counterparty. Collateral held varies, but may include cash, accounts receivable, inventory, property, equipment and real estate. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The subsidiary Bank had certificates of deposit, or other deposit accounts, in the amount of $133,200, $254,400 and $90,000 at September 30, 1995, December 31, 1994 and 1993, respectively, as collateral supporting those letter of credit commitments for which collateral is deemed necessary. Credit card lines available at December 31, 1994 and 1993 were collaterialized by deposits held at the Company's subsidiary Bank. There were no credit card lines available at September 30, 1995. The subsidiary Bank sold $21,660,000, $7,265,000 and $4,450,000 in federal funds at September 30, 1995, December 31, 1994 and 1993, respectively. These funds represent uncollateralized loans made by the Bank, in varying amounts, to commercial banks with whom the subsidiary Bank has correspondent relationships. The subsidiary Bank maintains deposits with other financial institutions in amounts which exceed FDIC insurance coverage. F-16 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATION OF CREDIT RISK: (CONTINUED) The subsidiary Bank has geographic concentrations of credit in its three principal trade areas, Grayson County, Angelina County and Tarrant County, Texas. Additionally, the subsidiary Bank has a significant concentration of credit, based upon like collateral, in its insurance premium finance portfolio. Insurance premium finance comprises approximately $23,724,000 or 35%, $20,496,000 or 32% and $14,200,000 or 45% of consolidated total loans net of unearned interest as of September 30, 1995, December 31, 1994 and 1993, respectively. 10. NET INCOME PER COMMON SHARE: Net income per common share for the nine months ended September 30, 1995 and for the years ended December 31, 1994, 1993 and 1992 was based upon 3,506,419, 2,393,841, 2,001,689, and 1,951,873 shares of common stock outstanding, respectively. The effects of the exercise of stock options and warrants are not material and have not been considered in the calculation of income per common share. 11. EMPLOYEE BENEFIT PLAN: Effective October 1, 1993, the Company adopted the Surety Bank 401(k) Plan ("Plan"). All full-time employees are eligible for participation. Under the terms of the Plan, eligible employees are allowed to contribute up to 10% of their base pay. The Company contributes amounts equal to 5% of the employee's contribution to a maximum of 5% of the employee's pay, subject to statutory limits. The expense for the Plan for the nine months ended September 30, 1995 and for 1994 and 1993 was $11,081, $13,650 and $2,889, respectively. Contributions to the plan during 1994 and 1993 were $30,000 and $25,000, respectively. 12. FEDERAL INCOME TAX: Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". In accordance with the provisions of this statement, the Company elected not to restate prior years and has determined that the cumulative effect of implementation was not significant. F-17 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. FEDERAL INCOME TAX: (CONTINUED) The components of the net deferred asset recognized at September 30, 1995 (unaudited), December 31, 1994 and 1993 are as follows:
SEPTEMBER DECEMBER DECEMBER 30, 1995 31, 1994 31, 1993 ----------- ----------- ----------- (UNAUDITED) Deferred tax liability: Depreciation and amortization......................... $ 365,599 $ 350,066 $ 135,696 Securities............................................ 34,286 34,286 34,286 Deferred loan costs................................... 24,772 18,700 -- Other................................................. 58,604 58,604 -- Net unrealized gain on available-for-sale investment securities........................................... 56,219 -- -- ----------- ----------- ----------- 539,480 461,656 169,982 Deferred tax asset: Tax net operating losses.............................. 40,373 163,366 270,558 Depreciation.......................................... 55,988 55,988 47,973 Allowance for loan losses............................. 148,480 128,080 26,307 Securities............................................ 83,667 224,238 -- Other................................................. 3,095 25,758 9,429 ----------- ----------- ----------- 331,603 597,430 354,267 Valuation allowance..................................... -- -- (184,285) ----------- ----------- ----------- Deferred tax asset/(liability).......................... 331,603 597,430 169,982 ----------- ----------- ----------- Net deferred tax asset/(liability).................. $(207,877) $ 135,774 $ -0- ----------- ----------- ----------- ----------- ----------- -----------
Gross net operating losses and the related valuation allowance disclosed in 1993 were adjusted to exclude net operating losses which the Company would not be able to utilize. This adjustment had no impact on the net deferred tax asset. The Company's effective tax rate on income before income taxes differs from the U.S. statutory tax rate as follows:
DECEMBER 31, SEPTEMBER 30, ------------------------------- 1995 1994 1993 1992 ----------------- --------- --------- --------- U.S. statutory rate (benefit)................................... 34.0% 34.0% 34.0% 34.0% Other........................................................... (.1) -- (2.9) -- Goodwill........................................................ 4.9 -- -- -- Valuation allowance............................................. -- (33.0) (31.1) -- Utilization of net operating losses............................. -- -- -- (34.0) Tax-exempt interest............................................. (7.1) (1.1) -- -- --- --------- --------- --------- Effective tax rate.............................................. 31.7% (.1)% -0- -0- --- --------- --------- --------- --- --------- --------- ---------
As of December 31, 1994, the Company has a net operating loss carryforward of approximately $480,473 for income tax reporting purposes which expires, if not used, in 2002 through 2008. The utilization of approximately $353,652 of the net operating loss carryforward is limited by Section 382 of the Internal Revenue Code to approximately $59,000 annually until its expiration in 1999 and $15,000 thereafter through 2004. F-18 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 13. OTHER NONINTEREST INCOME AND EXPENSE: Other noninterest income and expense for the nine months ended September 30, 1995 (unaudited) and for the years ended December 31, 1994, 1993 and 1992 was composed of the following:
SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31, DECEMBER 31, DECEMBER 31, 1995 1994 1994 1993 1992 ------------- ------------- ------------ ------------ ------------ (UNAUDITED) Noninterest Income: Nonsufficient fund charges........... $ 214,501 $ 202,674 $ 263,315 $ 248,890 $ 145,365 Late fee charges..................... 366,356 293,582 426,476 304,354 278,520 Service charges...................... 163,648 119,684 163,336 120,143 47,717 Collection fees...................... 93,536 77,001 96,162 71,760 44,351 Credit life insurance................ 59,570 33,231 44,402 49,777 46,346 Premium finance servicing............ -- -- -- 161,310 101,853 Secured credit card annual fee....... 4,487 13,774 15,905 36,968 52,837 Other................................ 153,897 60,859 150,411 97,843 67,077 Gain on sale of investment........... 100 -- -- 90,763 -- ------------- ------------- ------------ ------------ ------------ Total.............................. $ 1,056,095 $ 800,805 $1,160,007 $1,181,808 $ 784,066 ------------- ------------- ------------ ------------ ------------ ------------- ------------- ------------ ------------ ------------ General and administrative expense: Professional fees.................... $ 343,866 $ 264,627 $ 315,434 $ 362,571 $ 351,593 Office supplies...................... 193,466 150,187 201,028 165,416 126,880 Travel and entertainment............. 49,760 47,603 60,162 62,184 42,593 Telephone............................ 115,428 95,616 128,407 103,921 78,384 Advertising.......................... 65,216 43,146 54,683 60,302 88,589 Postage.............................. 150,301 97,349 133,887 125,092 105,229 Amortization of intangibles.......... 137,171 34,329 51,201 35,567 29,388 Dues and subscriptions............... 28,322 36,704 54,609 26,707 20,935 Insurance............................ 97,200 78,420 97,473 59,882 25,519 Credit cards......................... 14,707 44,698 59,573 63,298 83,941 Bank service charge.................. 29,914 18,901 25,808 29,018 17,922 FDIC assessment...................... 114,541 90,623 133,112 71,003 56,594 Credit reports....................... 40,911 15,025 17,714 48,495 27,256 Operational losses................... -- -- -- -- 62,044 Other................................ 188,950 135,733 257,723 167,515 111,707 ------------- ------------- ------------ ------------ ------------ $ 1,569,753 $ 1,152,961 $1,590,814 $1,380,971 $1,228,574 ------------- ------------- ------------ ------------ ------------ ------------- ------------- ------------ ------------ ------------
14. COMMITMENTS AND CONTINGENCIES: As of September 30, 1995 the Company leased its office space in Hurst, Texas under a noncancellable operating lease. The lease expires December 31, 1999. Future minimum lease payments are as follows: 1995...................................................... $ 94,713 1996...................................................... 109,324 1997...................................................... 114,253 1998...................................................... 114,253 1999...................................................... 119,181 --------- Total..................................................... $ 551,724 --------- ---------
F-19 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. COMMITMENTS AND CONTINGENCIES: (CONTINUED) Rent expense was $83,562 for the nine months ended September 30, 1995 and $62,297 for the nine months ended September 30, 1994, $83,062 for the year ended December 31, 1994, $56,982 for the year ended December 31, 1993, and $55,310 for the year ended December 31, 1992. The Company adopted an agreement which compensates certain executive officers at a rate of three times their annual salary for a change in control of approximately 20%. 15. PARENT COMPANY FINANCIAL INFORMATION: CONDENSED PARENT COMPANY ONLY STATEMENTS OF CONDITION AS OF SEPTEMBER 30, 1995 (UNAUDITED), DECEMBER 31, 1994 AND 1993
DECEMBER 31, SEPTEMBER 30, ---------------------- 1995 1994 1993 ------------- ---------- ---------- (UNAUDITED) Assets: Cash.......................................................................... $ 122,849 $ 324,658 $1,010,573 Interest bearing deposits in financial institutions........................... -- -- 450,000 Receivable from subsidiary.................................................... -- 242,493 -- Investment in Subsidiary, at equity........................................... 10,211,874 9,211,212 3,820,415 Other assets.................................................................. 83,170 51,232 -- ------------- ---------- ---------- Total assets................................................................ $ 10,417,893 $9,829,595 $5,280,988 ------------- ---------- ---------- ------------- ---------- ---------- Liabilities: Note payable.................................................................. $ 375,000 $1,750,000 $ -- Accrued liabilities........................................................... 6,192 13,914 -- ------------- ---------- ---------- Total liabilities........................................................... 381,192 1,763,914 -- ------------- ---------- ---------- Shareholders' equity: Common stock.................................................................. 35,166 30,408 22,734 Additional paid-in capital.................................................... 9,364,515 8,113,214 5,806,116 Retained earnings (deficit)................................................... 573,311 (75,102) (547,862) Treasury stock................................................................ (50,830) Unrealized gain (loss) on available-for-sale securities....................... 114,539 (2,839) -- ------------- ---------- ---------- Total shareholders' equity.................................................. 10,036,701 8,065,681 5,280,988 ------------- ---------- ---------- Total liabilities and shareholders' equity................................ $ 10,417,893 $9,829,595 $5,280,988 ------------- ---------- ---------- ------------- ---------- ----------
F-20 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 15. PARENT COMPANY FINANCIAL INFORMATION: (CONTINUED) CONDENSED PARENT COMPANY ONLY STATEMENTS OF INCOME FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1994 (UNAUDITED) AND FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
SEPTEMBER 30, DECEMBER 31, -------------------- ------------------------------- 1995 1994 1994 1993 1992 --------- --------- --------- --------- --------- (UNAUDITED) (UNAUDITED) Interest income....................... $ 6,459 $ 20,912 $ 24,685 $ 12,813 $ 13,517 Interest expense...................... (111,915) -- (11,075) -- -- --------- --------- --------- --------- --------- Net interest income (expense) before provision for loan loss............ (105,456) 20,912 13,610 12,813 13,517 Recovery on loan loss................. -- 3,101 3,101 64,416 65,445 --------- --------- --------- --------- --------- Net interest income................. (105,456) 24,013 16,711 77,229 78,962 Noninterest expense................... (184,868) (163,487) (207,473) (255,999) (355,862) Equity in net income of subsidiary.... 886,123 430,105 390,797 549,493 293,324 --------- --------- --------- --------- --------- Net income before income taxes.... 595,799 290,631 200,035 370,723 16,424 Income tax expense (benefit): Current............................. (52,614) -- (242,493) -- -- Deferred............................ -- (3,103) (30,232) -- -- --------- --------- --------- --------- --------- Net income........................ $ 648,413 $ 293,734 $ 472,760 $ 370,723 $ 16,424 --------- --------- --------- --------- --------- --------- --------- --------- --------- ---------
F-21 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 15. PARENT COMPANY FINANCIAL INFORMATION: (CONTINUED) CONDENSED PARENT COMPANY ONLY STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1995 AND 1994 AND FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
SEPTEMBER 30, DECEMBER 31, ------------------------ ---------------------------------- 1995 1994 1994 1993 1992 ----------- ----------- ----------- ---------- --------- (UNAUDITED) (UNAUDITED) Cash flows from operating activities: Net income................................................ $ 648,413 $ 293,734 $ 472,760 $ 370,723 $ 16,424 Adjustments to reconcile net income to net cash used in operating activities: Equity in net income of subsidiary...................... (886,123) (433,207) (390,797) (549,493) (293,324) Recovery on loan losses................................. -- -- -- (64,416) (65,445) Depreciation and amortization........................... -- -- -- -- 35,015 Net increase (decrease) in accrued liabilities.......... 109,656 -- 11,075 -- (155,648) Net increase in other assets............................ (82,768) (119,743) (51,232) -- -- ----------- ----------- ----------- ---------- --------- Net cash provided (used) in operating activities...... (210,822) (259,216) 41,806 (243,186) (462,978) ----------- ----------- ----------- ---------- --------- Cash flows from investing activities: Proceeds from the maturity of interest.................... -- 100,000 450,000 50,000 -- Purchase of interest bearing deposits..................... -- -- -- -- (500,000) Net (increase) decrease in receivable from subsidiary..... 242,493 -- (242,493) -- -- Net (increase) decrease in loans.......................... -- -- -- 207,582 185,480 Direct cost incurred for probable bank acquisition........ -- -- -- 71,935 (71,935) Investment in subsidiary.................................. (114,539) (1,000,000) (5,000,000) -- -- ----------- ----------- ----------- ---------- --------- Net cash (used) provided in investing activities...... 127,954 (900,000) (4,792,493) 329,517 (386,455) ----------- ----------- ----------- ---------- --------- Cash flows from financing activities: Sale of common stock...................................... 1,256,059 394,713 2,314,772 851,903 779,143 Short-term debt........................................... (1,375,000) -- 1,750,000 -- -- ----------- ----------- ----------- ---------- --------- Net cash provided in financing activities............. (118,941) 394,713 4,064,772 851,903 779,143 Net (decrease) increase in cash............................. (201,809) (764,503) (685,915) 938,234 (70,290) Beginning cash and cash equivalents......................... 324,658 1,010,573 1,010,573 72,339 142,629 ----------- ----------- ----------- ---------- --------- Ending cash and cash equivalents............................ $ 122,849 $ 246,070 $ 324,658 $1,010,573 $ 72,339 ----------- ----------- ----------- ---------- --------- ----------- ----------- ----------- ---------- ---------
F-22 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 16. SUBSEQUENT EVENTS: On October 17, 1995 the Company and Surety Bank entered into an agreement to acquire First National Bank, a national banking association located in Midlothian, Texas. Under the proposed structure of the transaction, a subsidiary of Surety Bank (to be organized by Surety Bank under the name of "Surety Acquisition, Inc.") will first merge with and into First National Bank's parent holding company, First Midlothian Corporation ("First Midlothian"), pursuant to which merger (the "Merger") the shareholders of First Midlothian will receive cash in exchange for their shares of capital stock of First Midlothian in an amount equal to one hundred and fifty percent (150%) of the book value of First National Bank. Surety Acquisition, Inc. will be a Texas corporation, and its proposed activities will be limited to facilitating Surety Bank's acquisition of First Midlothian and, indirectly, First National Bank. Immediately following the Merger, First National Bank and Surety Bank will consolidate under the charter of Surety Bank (the "Consolidation"). Upon consummation of the Consolidation, First Midlothian will be dissolved. The Company is in the process of preparing the various regulatory applications necessary to consummate the proposed acquisition. As of September 30, 1995 First Midlothian Corporation had total assets of $52,130,000, total deposits of $47,160,000, total net loans of $20,094,000, total equity of $3,763,000 and net income for the nine months ended September 30, 1995 of $306,000. The completion of the acquisition is subject to a number of contingencies, including regulatory approval by applicable banking authorities, the raising of sufficient funds by the Company to facilitate the acquisition, shareholder approval, and other matters. If consummated, the transactions are expected to occur during the first quarter of 1996. F-23 REPORT OF INDEPENDENT ACCOUNTANTS' Board of Directors and Shareholders First Midlothian Corporation Midlothian, Texas We have audited the accompanying consolidated balance sheets of First Midlothian Corporation as of September 30, 1995 and December 31, 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for the nine months ended September 30, 1995 and for each of the two years in the period ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Midlothian Corporation as of September 30, 1995 and December 31, 1994, and the consolidated results of their operations and their cash flows for the nine months ended September 30, 1995 and for each of the two years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. As discussed in Note 2 to the financial statements, First Midlothian Corporation changed its method of accounting for investment securities and income taxes in 1994 and 1993, respectively. SAMSON, ROBBINS & ASSOCIATES, P.L.L.C. November 1, 1995 Dallas, Texas F-24 FIRST MIDLOTHIAN CORPORATION CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 1995 AND DECEMBER 31, 1994 ASSETS
SEPTEMBER 30, DECEMBER 31, 1995 1994 ------------- ------------- Assets: Cash and due from banks.......................................................... $ 3,586,274 $ 2,150,392 Federal funds sold............................................................... 7,100,000 2,640,000 ------------- ------------- Cash and cash equivalents...................................................... 10,686,274 4,790,392 Investment securities.............................................................. 19,309,212 20,512,375 Net loans.......................................................................... 20,094,209 20,396,952 Premises and equipment, net........................................................ 861,532 854,488 Accrued interest receivable........................................................ 429,114 460,611 Other real estate and repossessed assets........................................... 653,035 1,046,724 Net deferred tax asset............................................................. 51,226 205,101 Other assets....................................................................... 45,640 48,423 ------------- ------------- Total assets................................................................. $ 52,130,242 $ 48,315,066 ------------- ------------- ------------- ------------- LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities: Demand deposits.................................................................. $ 10,154,310 $ 9,191,492 Savings, NOW and money markets................................................... 16,729,861 16,766,651 Time deposits, $100,000 and over................................................. 1,963,600 1,546,147 Other time deposits.............................................................. 18,312,770 16,096,716 ------------- ------------- Total deposits................................................................. 47,160,541 43,601,006 Subordinated debentures............................................................ 674,707 674,707 Accrued interest payable and other liabilities..................................... 531,893 468,933 ------------- ------------- Total liabilities.............................................................. 48,367,141 44,744,646 Commitments and contingent liabilities............................................. -- -- Shareholders' equity: Common stock, $10 par value, 48,000 shares authorized, issued and outstanding.... 480,000 480,000 Additional paid-in capital......................................................... 679,493 679,493 Retained earnings.................................................................. 2,603,608 2,417,344 Unrealized loss on available-for-sale securities................................... 0 (6,417) ------------- ------------- Total shareholders' equity..................................................... 3,763,101 3,570,420 ------------- ------------- Total liabilities and shareholders' equity................................... $ 52,130,242 $ 48,315,066 ------------- ------------- ------------- -------------
The accompanying notes are an integral part of the consolidated financial statements. F-25 FIRST MIDLOTHIAN CORPORATION CONSOLIDATED STATEMENTS OF INCOME
FOR THE FOR THE FOR THE NINE MONTHS ENDED YEAR ENDED YEAR ENDED SEPTEMBER 30, 1995 DECEMBER 31, 1994 DECEMBER 31, 1993 ------------------ ----------------- ----------------- Interest income: Commercial and real estate loans.................................... $1,240,594 $1,466,820 $1,555,773 Consumer loans...................................................... 296,496 351,874 299,759 Federal funds sold.................................................. 320,679 185,581 341,754 Investment securities and interest bearing deposits................. 866,236 963,043 659,231 Other interest income............................................... 1,757 32,621 35,923 ------------------ ----------------- ----------------- Total interest income............................................. 2,725,762 2,999,939 2,892,440 ------------------ ----------------- ----------------- Interest expense: Savings, NOW and money markets...................................... 368,646 327,632 363,056 Time deposits, $100,000 and over.................................... 202,403 134,369 121,505 Other time deposits................................................. 595,985 627,142 641,687 Other interest expense.............................................. 68,011 81,777 88,846 ------------------ ----------------- ----------------- Total interest expense............................................ 1,235,045 1,170,920 1,215,094 ------------------ ----------------- ----------------- Net interest income before provision for loan losses............ 1,490,717 1,829,019 1,677,346 Provision for loan losses............................................. 35,000 0 0 ------------------ ----------------- ----------------- Net interest income............................................. 1,455,717 1,829,019 1,677,346 ------------------ ----------------- ----------------- Noninterest income.................................................... 469,788 627,846 645,961 ------------------ ----------------- ----------------- Noninterest expense: Salaries and employee benefits...................................... 720,361 941,462 881,923 Occupancy and equipment............................................. 156,170 194,860 181,048 General and administrative.......................................... 592,140 936,371 1,035,401 ------------------ ----------------- ----------------- Total noninterest expense......................................... 1,468,671 2,072,693 2,098,372 ------------------ ----------------- ----------------- Income before income taxes...................................... 456,834 384,172 224,935 Income tax expense: Current............................................................. 0 0 0 Deferred............................................................ 150,570 109,229 57,632 ------------------ ----------------- ----------------- Total tax expense............................................... 150,570 109,229 57,632 ------------------ ----------------- ----------------- Net income...................................................... $ 306,264 $ 274,943 $ 167,303 ------------------ ----------------- ----------------- ------------------ ----------------- ----------------- Net income per share of common stock.................................. $ 6.38 $ 5.73 $ 3.49 ------------------ ----------------- ----------------- ------------------ ----------------- ----------------- Weighted average shares outstanding................................... 48,000 48,000 48,000 ------------------ ----------------- ----------------- ------------------ ----------------- -----------------
The accompanying notes are an integral part of the consolidated financial statements. F-26 FIRST MIDLOTHIAN CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
UNREALIZED GAIN/(LOSS) ON COMMON STOCK ADDITIONAL AVAILABLE TOTAL --------------------- PAID-IN RETAINED FOR SALE SHAREHOLDERS' SHARES PAR VALUE CAPITAL EARNINGS SECURITIES EQUITY --------- ---------- ---------- ------------ ----------- ------------- Balance at December 31, 1992 as previously reported................. 48,000 $ 480,000 $ 679,493 $ 1,605,971 $ 0 $ 2,765,464 Cumulative effect on prior years of change in accounting principle...... 369,127 369,127 --------- ---------- ---------- ------------ ----------- ------------- Balance at December 31, 1992 as restated............................ 48,000 480,000 679,493 1,975,098 0 3,134,591 Net income........................... 167,303 167,303 --------- ---------- ---------- ------------ ----------- ------------- Balance at December 31, 1993......... 48,000 480,000 679,493 2,142,401 0 3,301,894 Net income 274,943 274,943 Unrealized (loss) on available- for-sale securities, net of income taxes............................... (6,417) (6,417) --------- ---------- ---------- ------------ ----------- ------------- Balance at December 31, 1994......... 48,000 480,000 679,493 2,417,344 (6,417) 3,570,420 Net income........................... 306,264 306,264 Dividends paid....................... (120,000) (120,000) Unrealized gain on available-for-sale securities, net of income taxes..... 6,417 6,417 --------- ---------- ---------- ------------ ----------- ------------- Balance at September 30, 1995........ 48,000 $ 480,000 $ 679,493 $ 2,603,608 $ 0 $ 3,763,101 --------- ---------- ---------- ------------ ----------- ------------- --------- ---------- ---------- ------------ ----------- -------------
The accompanying notes are an integral part of the consolidated financial statements. F-27 FIRST MIDLOTHIAN CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED FOR THE YEAR FOR THE YEAR SEPTEMBER 30, ENDED DECEMBER ENDED DECEMBER 1995 31, 1994 31, 1993 ------------- -------------- -------------- Cash flows from operating activities: Net income...................................................... $ 306,264 $ 274,943 $ 167,303 Adjustment to reconcile net income to net cash provided by operating activities: Provision for loan loss....................................... 35,000 0 0 Depreciation.................................................. 54,900 72,300 63,600 (Discount accretion)/premium amortization..................... (98,834) (19,895) 155,671 Loss on sale or disposal of other real estate................. 57,250 76,061 189,967 Loss on sale of investment securities......................... 0 15,548 0 Net change in accrued interest receivable..................... 31,497 (9,236) 4,123 Net change in other assets.................................... 2,137 24,696 15,224 Net change in deferred tax asset.............................. 150,570 109,227 57,632 Net change in accrued interest payable and other liabilities.................................................. 63,606 (13,800) (88,163) ------------- -------------- -------------- Net cash provided by operating activities................... 602,390 529,844 565,357 ------------- -------------- -------------- Cash flows from investing activities: Proceeds from the maturity of held-to-maturity securities and interest bearing deposits...................................... 11,320,000 18,365,125 20,822,000 Proceeds from maturity of available-for-sale securities......... 4,000,000 0 0 Purchase of premises and equipment.............................. (61,945) (87,408) (62,953) Net decrease in loans........................................... 267,743 307,459 59,028 Proceeds from sale of other real estate......................... 336,440 377,819 598,850 Purchase of held-to-maturity securities......................... (14,008,281) (15,906,164) (20,186,250) Purchase of available-for-sale securities....................... 0 (3,927,657) 0 ------------- -------------- -------------- Net cash provided by (used in) investing activities......... 1,853,957 (870,826) 1,230,675 ------------- -------------- -------------- Cash flows from financing activities: Net change in deposits.......................................... 3,559,535 (2,097,951) (4,622,469) Payments on debentures.......................................... 0 (99,040) (62,203) Dividends paid.................................................. (120,000) 0 0 ------------- -------------- -------------- Net cash provided by (used in) financing activities......... 3,439,535 (2,196,991) (4,684,672) ------------- -------------- -------------- Net increase (decrease) in cash................................... 5,895,882 (2,537,973) (2,888,640) Beginning cash and cash equivalents............................... 4,790,392 7,328,365 10,217,005 ------------- -------------- -------------- Ending cash and cash equivalents.................................. $ 10,686,274 $ 4,790,392 $ 7,328,365 ------------- -------------- -------------- ------------- -------------- -------------- Supplemental disclosure: Cash paid during the period for interest........................ $ 1,127,892 $ 1,182,505 $ 1,267,670 ------------- -------------- -------------- ------------- -------------- -------------- Cash paid during the period for income taxes.................... $ 0 $ 0 $ 0 ------------- -------------- -------------- ------------- -------------- --------------
The accompanying notes are an integral part of the consolidated financial statements F-28 FIRST MIDLOTHIAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION: The accompanying consolidated financial statements include the accounts of the Company and its subsidiary, First National Bank in Midlothian ("Bank"), which is 100% owned. All significant intercompany transactions and balances have been eliminated in consolidation. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are sold for one day periods. INVESTMENT SECURITIES Effective January 1, 1994, the Company adopted STATEMENT OF FINANCIAL ACCOUNTING STANDARDS No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). This statement addresses the accounting and reporting for investments in equity securities that have readily determined fair values for all investments in debt securities. Management determines the appropriate classification of securities at time of purchase. If the securities are purchased with the positive intent and the ability to hold the securities until maturity, they are classified as held-to-maturity and carried at historical cost, adjusted for amortization of premiums and accretion of fees and discounts using the effective interest method. Securities to be held for indefinite periods of time are classified as available-for-sale and carried at fair value. Securities purchased and held principally for the purpose of selling them in the near term are classified as trading. The Company has no securities classified as trading as of September 30, 1995. The cost of securities sold is based on the specific identification method. The Company has no securities classified as available-for-sale at September 30, 1995. LOANS AND ALLOWANCE FOR LOAN LOSSES Loans are stated at the amount of unpaid principal, reduced by unearned interest and an allowance for loan losses. The allowance for loan losses is established through a provision for loan losses charged against current earnings. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance for loan losses is an amount that management believes will be adequate to absorb possible losses on existing loans that may become uncollectible, based upon evaluation of the collectibility of loans and prior loan loss experience. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrowers' ability to pay. Interest income on installment loans is recognized by a method which approximates the interest method. Interest income on commercial and real estate loans is accrued daily on the amount of outstanding principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that a borrower's financial condition is such that collection of interest and principal is doubtful. Management evaluates the book value (including accrued interest) and collateral value on loans placed on nonaccrual status and provides specific allowance for loan losses as deemed appropriate. Certain fees and costs associated with the origination of loans are recognized when received. Management has determined that fees collected offset actual expenses incurred to process the subject loans. PREMISES AND EQUIPMENT Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method at rates sufficient to amortize the cost over the estimated lives of the assets. Expenditures for repairs and maintenance are expensed as incurred, and renewals and betterments that F-29 FIRST MIDLOTHIAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) extend the lives of assets are capitalized. Cost and accumulated depreciation are eliminated from the accounts when assets are sold or retired and any resulting gain or loss is reflected in operations in the year of disposition. OTHER REAL ESTATE AND REPOSSESSED ASSETS Foreclosed real estate and other assets are recorded at the lower of the unpaid balance of the related loan or the fair market value of the property. Any write down to fair market value at the date of acquisition is charged against the allowance for loan losses. Any subsequent write downs are reflected in operations. INCOME PER SHARE Net income per share of common stock is computed based upon the weighted average number of shares of common stock outstanding during the years ended December 31, 1994 and 1993 and for the nine months ended September 30, 1995. INCOME TAXES During 1993, the Company adopted STATEMENT OF FINANCIAL ACCOUNTING STANDARDS (SFAS) No. 109 whereby the method of accounting for income taxes utilized an asset and liability approach for financial statement purposes. Under SFAS No. 109, the types of differences between the tax bases of assets and liabilities and their financial reporting amounts that give rise to significant portions of deferred income tax liabilities or assets include: allowances for possible loan losses, property and equipment, investment securities and net operating loss carryforwards. The change in accounting did not have an effect on the Company's consolidated financial position or results of operations. First Midlothian Corporation and its subsidiary will file a consolidated tax return for 1995. The Company has a tax sharing arrangement with its subsidiary. 3. INVESTMENT SECURITIES: At September 30, 1995 the amortized cost and estimated market values of investment securities are as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES MARKET VALUE ------------- ----------- ----------- ------------- Held-to-Maturity: U.S. Treasury............................................ $ 18,000,874 $ 45,676 $ 5,340 $ 18,041,210 Obligations of other U.S. Government agencies and corporations............................................ 1,000,000 2,190 0 1,002,190 State and county municipals.............................. 263,938 2,964 0 266,902 Federal Reserve Bank stock............................... 44,400 0 0 44,400 ------------- ----------- ----------- ------------- $ 19,309,212 $ 50,830 $ 5,340 $ 19,354,702 ------------- ----------- ----------- ------------- ------------- ----------- ----------- -------------
F-30 FIRST MIDLOTHIAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. INVESTMENT SECURITIES: (CONTINUED) At December 31, 1994 the amortized cost and estimated market values of investment securities are as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES MARKET VALUE ------------- ----------- ----------- ------------- Held-to-Maturity: U.S. Treasury............................................ $ 16,258,839 $ 0 $ 170,257 $ 16,088,582 Obligations of other U.S. Government agencies and corporations............................................ 0 0 0 0 State and county municipals.............................. 283,736 1,623 0 285,359 Federal Reserve Bank stock............................... 44,400 0 0 44,400 ------------- ----------- ----------- ------------- 16,586,975 1,623 170,257 16,418,341 ------------- ----------- ----------- ------------- Available-for-Sale: U.S. Treasury............................................ 3,935,122 0 9,722 3,925,400 Obligations of other U.S. Government agencies and corporations............................................ 0 0 0 0 ------------- ----------- ----------- ------------- 3,935,122 0 9,722 3,925,400 ------------- ----------- ----------- ------------- $ 20,522,097 $ 1,623 $ 179,979 $ 20,343,741 ------------- ----------- ----------- ------------- ------------- ----------- ----------- -------------
The amortized cost and estimated market value of investment securities at September 30, 1995, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
AMORTIZED ESTIMATED COST MARKET VALUE ------------- ------------- Held-to-Maturity: Due within one year.................................................... $ 6,990,206 $ 6,999,510 Due after one year through five years.................................. 12,249,938 12,285,792 Due after five years through ten years................................. 24,668 25,000 Other Securities....................................................... 44,400 44,400 ------------- ------------- Total................................................................ $ 19,309,212 $ 19,354,702 ------------- ------------- ------------- -------------
Proceeds from maturities of investment securities during the nine months ended September 30, 1995 were $15,320,000 with no gross recognized gains or losses. Proceeds from maturities of investment securities during the twelve months ended December 31, 1994 were $18,365,125 with gross recognized losses of $15,548. These securities were sold within ninety (90) days of the maturity dates and did not impact the classification of other held-to-maturity securities. Proceeds from maturities of investment securities during the twelve months ended December 31, 1993 were $20,822,000 with no gross recognized gains or losses. At September 30, 1995, and December 31, 1994, the carrying value of Federal Reserve Bank stock was $44,400. The Federal Reserve Bank stock's market value was estimated to be the same as its carrying value at both September 30, 1995 and December 31, 1994. At September 30, 1995 and December 31, 1994, securities with a carrying amount of approximately $6,550,000 and $7,537,000, respectively, were pledged as collateral for public deposits, as required or permitted by law. F-31 FIRST MIDLOTHIAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. INVESTMENT SECURITIES: (CONTINUED) At September 30, 1995, there were no investment securities classified as available-for-sale securities. The gross unrealized loss on the available-for-sale securities at December 31, 1994 was $9,722. 4. NET LOANS: The loan portfolio was composed of the following:
SEPTEMBER 30, DECEMBER 31, 1995 1994 ------------- ------------- Commercial loans......................................................... $ 4,210,529 $ 5,505,238 Real estate loans........................................................ 12,378,272 11,550,776 Installment loans........................................................ 3,958,983 3,659,907 Overdrafts............................................................... 5,613 122,934 ------------- ------------- Total loans............................................................ 20,553,397 20,838,855 Deduct: Unearned interest...................................................... (228,573) (185,320) Allowance for loan losses.............................................. (230,615) (256,583) ------------- ------------- Net loans............................................................ $ 20,094,209 $ 20,396,952 ------------- ------------- ------------- -------------
A summary of the changes in the allowance for loan losses for the nine months ended September 30, 1995 and years ended December 31, 1994 and 1993 are as follows:
1995 1994 1993 ---------- ---------- ---------- Beginning balance.................................................. $ 256,583 $ 317,372 $ 346,582 Provision for loan losses.......................................... 35,000 0 0 Loans charged off.................................................. (82,919) (84,079) (45,416) Recoveries......................................................... 21,951 23,290 16,206 ---------- ---------- ---------- $ 230,615 $ 256,583 $ 317,372 ---------- ---------- ---------- ---------- ---------- ----------
Note that no provision for loan losses was recorded during the two years ended December 31, 1993 and 1994, respectively. During 1991, the Company was required to increase the allowance for loan loss significantly based upon actual experience levels at that time. Subsequent to 1991, the Company's experience relative to loan loss has improved such that no material provision has been required. Loans on which the accrual of interest has been discontinued amounted to approximately $128,621 and $52,663 at September 30, 1995 and December 31, 1994, respectively. Included in commercial and installment loans at September 30, 1995 and December 31, 1994, are approximately $934,378 and $1,414,804, respectively, of loans to employees, officers, and/or directors, or their interests. 5. OTHER REAL ESTATE AND REPOSSESSED ASSETS: Other real estate and repossessed assets consisted of the following at:
SEPTEMBER 30, DECEMBER 31, 1995 1994 1993 ------------- ------------ ------------ Other real estate............................................ $ 713,268 $ 1,173,812 $ 1,511,764 Allowance for possible loss: Beginning balance.......................................... (127,088) (140,151) (250,613) Charge offs................................................ 69,441 13,063 123,285 Provision charged to expense............................... (2,586) -- (12,823) ------------- ------------ ------------ Ending balance............................................. (60,233) (127,088) (140,151) ------------- ------------ ------------ Net other real estate........................................ $ 653,035 $ 1,046,724 $ 1,371,613 ------------- ------------ ------------
F-32 FIRST MIDLOTHIAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. PREMISES AND EQUIPMENT: Premises and equipment at September 30, 1995 and December 31, 1994 are summarized as follows:
1995 1994 ------------ ------------ Land........................................................................ $ 64,277 $ 64,277 Building.................................................................... 989,222 971,697 Furniture, fixtures and computers........................................... 399,200 646,761 Automobiles................................................................. 53,289 53,289 ------------ ------------ 1,505,988 1,736,024 Less accumulated depreciation............................................... (644,456) (881,536) ------------ ------------ Net premises and equipment.................................................. $ 861,532 $ 854,488 ------------ ------------ ------------ ------------
During 1995, the Company adjusted premises and equipment to reflect obsolete, non-utilized items that were fully depreciated in prior years. The effect was to reduce the asset cost and accumulated depreciation by approximately $291,000. Depreciation expense was $54,900, $72,300 and $63,600 for the period ended September 30, 1995 and the years ended December 31, 1994 and 1993, respectively. 7. SUBORDINATED DEBENTURES: Subordinated Debentures at September 30, 1995 and December 31, 1994 are summarized as follows:
1995 1994 ---------- ---------- 1982 Subordinated Debentures......................................... 12% $ 339,707 $ 339,707 1991 Subordinated Debentures: Series D........................................................... 9.75% 55,000 55,000 Series E........................................................... 9.75% 70,000 70,000 Series F........................................................... 10.00% 70,000 70,000 Series G........................................................... 10.00% 70,000 70,000 Series H........................................................... 10.00% 70,000 70,000 ---------- ---------- $ 674,707 $ 674,707 ---------- ---------- ---------- ----------
Interest is payable semiannually with the principle due at maturity. The following is a summary of maturities of Subordinated Debentures at September 30, 1995. Due within one year....................................................... $ 55,000 Due after one year through five years..................................... 619,707 --------- $ 674,707 --------- ---------
The 1982 Subordinated Debentures are held by several shareholders of the Company. The 1991 Subordinated Debentures are held by shareholders with the exception of $100,000 which is held by two (2) significant customers of the Bank. 8. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK: The Company's subsidiary Bank is party to financial instruments with off-balance sheet risk, entered into in the normal course of business to meet the financing needs of its customers. These financial instruments include loan commitments and letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. F-33 FIRST MIDLOTHIAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK: (CONTINUED) The subsidiary Bank's exposure to credit loss in the event of nonperformance by counterparties to loan commitments and letters of credit is represented by the contractual amount of those instruments. The subsidiary Bank uses the same credit policies in making commitments and conditional obligations as are used in underwriting on-balance sheet instruments. The total amounts of financial instruments with off-balance sheet risk at September 30, 1995 and December 31, 1994 are as follows:
1995 1994 ---------- ---------- Unfunded loan commitments....................................................... $ 708,561 $ 761,132 Letters of credit............................................................... 79,597 80,602
Since many of the loan commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Loans are made in accordance with formal written loan policies. The subsidiary Bank evaluates each customer's credit worthiness on a case by case basis. The amount of collateral obtained, if deemed necessary by the subsidiary Bank, upon extension of credit is based on management's evaluation of the counterparty. Collateral held varies, but may include cash, accounts receivable, inventory, property, equipment and real estate. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. There was no collateral required by management for the letters of credit. The subsidiary Bank sold $7,100,000 and $2,640,000 in federal funds at September 30, 1995 and December 31, 1994, respectively. These funds represent uncollateralized loans made by the Bank, in varying amounts, to commercial banks with whom the subsidiary Bank has correspondent relationships. The subsidiary Bank maintains deposits with other financial institutions in amounts which exceed FDIC insurance coverage. At September 30, 1995 and December 31, 1994, approximately $1,998,006 and $0, respectively, of such balances were uninsured. 9. SHAREHOLDERS' EQUITY: In 1982, the Company acquired all of the common stock of the subsidiary Bank. Shareholders of the Bank stock were issued the same number of shares of common stock of the Company as they had held in the Bank. The Company does not have any warrants or options issued or outstanding. The Company is not subject to any restrictions on the amount of dividends that it may declare by any regulatory agency, however dividends must be paid out of retained earnings. On June 30, 1995, the Company declared and paid a $2.50 per share dividend for the shareholders of record as of that date. 10. NET INCOME PER COMMON SHARE: Net income per common share for the periods ended September 30, 1995 and December 31, 1994 and 1993 was based upon the weighted average shares of common stock outstanding of 48,000 shares, respectively. 11. FEDERAL INCOME TAX: Effective January 1, 1993, the Company adopted STATEMENT OF FINANCIAL ACCOUNTING STANDARDS (SFAS) No. 109, "Accounting for Income Taxes". In accordance with the provisions of this statement, the Company elected to restate prior years by recording the cumulative effect of this restatement as an increase to retained earnings of approximately $370,000 at January 1, 1993. F-34 FIRST MIDLOTHIAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. FEDERAL INCOME TAX: (CONTINUED) The components of the net deferred asset recognized at September 30, 1995 and December 31, 1994 are as follows:
1995 1994 --------- ---------- Deferred tax liability: Allowance for loan losses...................................................... $ 20,477 $ 32,379 --------- ---------- 20,477 32,379 --------- ---------- Deferred tax asset: Tax net operating losses....................................................... 51,195 203,006 Depreciation................................................................... 1,115 1,115 Securities..................................................................... 8,945 12,250 Allowance for real estate losses............................................... 10,448 21,109 --------- ---------- 71,703 237,480 --------- ---------- Valuation allowance.............................................................. 0 0 --------- ---------- Net deferred tax asset....................................................... $ 51,226 $ 205,101 --------- ---------- --------- ----------
The Company's effective tax rate on income before income taxes differs from the U.S. statutory tax rate as follows:
DECEMBER 31, SEPTEMBER 30, -------------------- 1995 1994 1993 ----------------- --------- --------- U.S. statutory rate.............................................. 34.0% 34.0% 34.0% Tax-exempt interest.............................................. (1.0)% (5.6)% (8.4)% --- --- --- Effective tax rate............................................... 33.0% 28.4% 25.6% --- --- --- --- --- ---
As of September 30, 1995, the Company has a net operating loss carryforward of approximately $150,000 for income tax reporting purposes which expires, if not used, in 2005 through 2008. F-35 FIRST MIDLOTHIAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 12. OTHER NONINTEREST INCOME AND EXPENSE: Other noninterest income and expense for the nine months ended September 30, 1995, and the years ended December 31, 1994, 1993 were composed of the following:
SEPTEMBER 30, DECEMBER 31, DECEMBER 31, 1995 1994 1993 ------------- ------------ ------------ Noninterest income: Service charges.................................................... $ 396,109 $ 513,834 $ 517,836 Other fees......................................................... 39,772 50,559 51,940 Other.............................................................. 33,907 63,453 76,185 ------------- ------------ ------------ Total............................................................ $ 469,788 $ 627,846 $ 645,961 ------------- ------------ ------------ ------------- ------------ ------------ General and administrative expense: Data processing.................................................... $ 150,706 $ 207,875 $ 195,821 FDIC and exam assessments.......................................... 38,078 134,600 154,201 ORE expense........................................................ 85,147 122,097 288,128 Office expense..................................................... 80,410 119,314 121,804 Directors fees..................................................... 58,600 64,095 67,820 Advertising........................................................ 50,026 53,939 58,645 Professional fees.................................................. 43,137 49,895 27,941 Loss on maturity of securities..................................... -- 15,548 -- Other.............................................................. 86,036 169,008 121,041 ------------- ------------ ------------ Total............................................................ $ 592,140 $ 936,371 $1,035,401 ------------- ------------ ------------ ------------- ------------ ------------
13. COMMITMENTS AND CONTINGENCIES: In the ordinary course of business, the Company has various outstanding commitments and contingent liabilities that are not reflected in the accompanying financial statements. Management does not anticipate any material adverse effect on the financial condition of the Company as a result of these commitments. The Company is party to various operating leases and contracts. The Company has a contract with Electronic Data Systems (EDS) to provide data processing services for the subsidiary Bank. This contract, which expires February 28, 1997, is based on usage and items processed. The average cost of this contract over the past past three years is approximately $10,000 -- $12,000 per month. This agreement can be canceled with a six month notice but requires the Bank to pay for the remaining term of the contract at 80% of the normal usage. In addition, the Company has a maintenance agreement for the drive-in turbo lanes and leases offsite storage facilities. The maintenance agreement is for a term of seven years and expires in March, 1996. The storage lease is for a term of two years and expires in March, 1997. These agreements cost $1,800 per year and $550 per month, respectively. The following is a schedule of future estimated minimum payments required under these operating leases: 1996...................................................... $ 112,650 1997...................................................... 19,250 --------- Total minimum payment..................................... $ 131,900 --------- ---------
In the normal course of business, the subsidiary Bank may become involved in routine claims and lawsuits. While the results of litigation cannot be predicted with certainty, management, in consultation with legal counsel, believes that the final outcome of any of these matters, or of any unasserted claims, will not have a material adverse effect on the Company's financial condition or results of operations. F-36 FIRST MIDLOTHIAN CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. RESTRICTIONS ON RETAINED EARNINGS: The primary source of funds for cash distributions by the Company to its shareholders is dividends received from its subsidiary Bank. The amount of dividends that the subsidiary Bank may declare in a calendar year without approval by the OCC is the Bank's net profits for that year combined with its net retained profits, as defined, for the two preceding years. At September 30, 1995, approximately $465,000 of the Bank's retained earnings were available for dividend distribution to the Company without prior regulatory approval. 15. REGULATORY MATTERS: The Company's subsidiary Bank 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 Bank's financial statements. The regulations require the Bank to meet specific capital adequacy guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under the regulatory accounting practices. The Bank's capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The Bank must maintain a minimum of qualifying total capital and core capital to risk-weighted assets of 8% and 4%, respectively. Management believes, as of September 30, 1995, that the Bank meets all capital requirements to which it is subject. The following is a summary of the Bank's capital ratios at September 30, 1995 and December 31, 1994:
SEPTEMBER 30, DECEMBER 31, 1995 1994 --------------- -------------- Total capital to risk-weighted assets................. 19.67% 19.30% Core capital to risk-weighted assets.................. 18.66% 18.15% Capital to total assets (leverage).................... 8.28% 8.56%
16. SUBSEQUENT EVENT: The Company has entered into a contract to be acquired by Surety Capital, a bank holding company located in Hurst, Texas. Surety Capital intends to merge the sole subsidiary of the Company, First National Bank of Midlothian, with and into Surety Capital's subsidiary, Surety Bank, National Association. It is anticipated that First Midlothian Corporation will be dissolved upon completion of the merger of the two banks. The current shareholders of the Company will receive cash in exchange for the stock held in the Company as a result of this transaction. The Board of Directors of the Company has approved this transaction. However, the completion of the purchase is subject to a number of contingencies, including approval by the applicable banking authorities, due diligence review of the Company's business operations, the raising of sufficient funds by Surety Capital to facilitate the acquisition, shareholder approval by the Company's shareholders and Surety Bank shareholders, and other matters. Assuming all activities are satisfactorily completed, the transaction is expected to close during the first quarter of 1996. F-37 - ------------------------------------------- ------------------------------------------- - ------------------------------------------- ------------------------------------------- THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION IN SUCH JURISDICTION. NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS OR THE DOCUMENTS INCORPORATED BY REFERENCE HEREIN IN CONNECTION WITH THE OFFERING MADE HEREBY, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE SELLING SHAREHOLDER. NEITHER THE DELIVERY OF THIS PROSPECTUS OR ANY PROSPECTUS SUPPLEMENT NOR ANY SALE MADE HEREUNDER OR THEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION HEREIN OR THEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE OF SUCH INFORMATION. ------------------- TABLE OF CONTENTS
PAGE --------- Prospectus Summary............................. 2 Summary Consolidated Financial Data............ 4 Investment Considerations...................... 5 Use of Proceeds................................ 6 Capitalization................................. 7 Market Price and Dividend Policy............... 7 The Midlothian Bank Acquisition................ 8 Management's Discussion and Analysis of Financial Condition and Results of Operations.................................... 14 Business....................................... 35 Regulation and Supervision..................... 39 Management..................................... 46 Selling Shareholder............................ 51 Beneficial Stock Ownership..................... 51 Description of Securities...................... 53 Underwriting................................... 53 Legal Matters.................................. 54 Experts........................................ 54 Available Information.......................... 54 Index to Financial Statements.................. F-1
2,100,000 Shares Surety Capital Corporation Common Stock -------- PROSPECTUS , 1996 -------- HOEFER & ARNETT Incorporated - ------------------------------------------- ------------------------------------------- - ------------------------------------------- ------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table sets forth the various expenses to be borne by the Company in connection with the sale and distribution of the securities being registered other than underwriting discounts and commissions. All of the amounts shown are estimates, except the Securities and Exchange Commission registration fee. Registration Fee.................................................. $ 2,704 Printing and Electronic Filing Expenses........................... 50,000 Legal Fees and Expenses........................................... 50,000 Accounting Fees and Expenses...................................... 30,000 Underwriting Expenses............................................. 172,000 Miscellaneous..................................................... 20,000 --------- Total......................................................... $ 324,704 --------- ---------
Expenses of the Selling Shareholder in connection with the sale and distribution of its securities being registered other than underwriting discounts and commissions are estimated to be approximately $30,000, reflecting underwriting, legal, and miscellaneous expenses. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Section 145 of the General Corporation Law of the State of Delaware (the "Act") empowers a corporation to indemnify its directors and officers and to purchase insurance with respect to liability arising out of their capacity as directors and officers. The Act further provides that the indemnification permitted thereunder shall not be deemed exclusive of any other rights to which the directors and officers may be entitled under the corporation's bylaws, any agreement, vote of the shareholders, or otherwise. Section 6.04 of the Company's Bylaws provides that the Company shall indemnify all persons to the full extent allowable by law who, by reason of the fact that they are or were a director of the Company, become a party or are threatened to be made a party to any indemnifiable action, suit or proceeding. The Company shall pay, in advance of the final disposition of any indemnifiable action, suit or proceeding under this bylaw, all reasonable expenses incurred by a director, upon receipt of an undertaking by or on behalf of a director to repay such amount if it is ultimately determined that he is not entitled to be indemnified by the Company under the law. The Company may indemnify persons other than directors, such as officers and employees, as permitted by law. The Company may purchase and maintain insurance on behalf of directors, officers and other persons against any liability asserted against him, whether or not the Company would have the power to indemnify such person against such liability, as permitted by law. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. 1. REGULATION S OFFERING. In April 1994, Surety Capital Corporation offered up to 1,555,555 shares of common stock in an offering conducted pursuant to Regulation S promulgated under the Securities Act of 1933, as amended. The sum of 355,000 shares was ultimately sold to four investors $4.50 per share, resulting in aggregate sale proceeds of $1,597,500. For each share of common stock acquired in the Regulation S offering, purchasers also received one warrant giving the holder thereof the right to acquire one additional share of the Company's common stock at a price of $4.50 per share. All of such warrants expired on April 1, 1994 without exercise. The shares were sold on a best efforts basis by Masters Financial Group, Inc., a broker-dealer, registered with the National Association of Securities Dealers, Inc., which received commissions of 10% of the gross proceeds from sales. In addition to commissions, Masters Financial Group, Inc. also received a warrant to acquire 35,500 shares of the Company's common stock at an exercise price of $4.50. This warrant expired unexercised on June 17, 1995. 2. REGULATION D OFFERING. In December 1994, the Company offered up to 1,538,462 shares of common stock in an offering conducted pursuant to Rule 506 of Regulation D promulgated by the Securities and Exchange Commission under the Securities Act of 1933, as amended. The Company ultimately sold 667,400 shares at a price of $3.25 per share to seven investors, resulting in aggregate sales proceeds of approximately II-1 $2,169,050. The shares were sold on a best efforts basis by Bentley Securities Corporation, a broker-dealer registered with the National Association of Securities Dealers, Inc., which received commissions of 5% of gross proceeds from sales. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. The exhibits and financial statement schedules listed on the accompanying Exhibit Index are filed as part of this Registration Statement and such Exhibit Index is hereby incorporated by reference. ITEM 17. UNDERTAKINGS. The Registrant hereby undertakes: (1) To file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement: (i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; (ii) To reflect in the prospectus any facts or events arising after the effective date of the Registration Statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the Registration Statement; and (iii) To include any material information with respect to the plan of distribution not previously disclosed in the Registration Statement or any material change to such information in the Registration Statement. (2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new Registration Statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. (4) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. (5) That, for purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (6) That, for the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (7) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-2 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant and has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Hurst, Texas on the 25th of January 1996. SURETY CAPITAL CORPORATION By: /s/ C. JACK BEAN ------------------------------------------ C. Jack Bean, Chairman of the Board Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE - ----------------------------------------- ------------------------------------------------ -------------------- /s/ C. JACK BEAN Chairman of the Board and Director (Principal January 25, 1996 -------------------------------- Executive Officer) C. Jack Bean /s/ BOB HACKLER Senior Vice President, January 25, 1996 -------------------------------- Secretary and Director Bob Hackler /s/ B.J. CURLEY Vice President and Chief Financial Officer January 25, 1996 -------------------------------- (Principal Financial Officer and B.J. Curley Chief Accounting Officer) /s/ CULLEN W. TURNER Director January 25, 1996 -------------------------------- Cullen W. Turner /s/ G. M. HEINZELMANN Director January 25, 1996 -------------------------------- G. M. Heinzelmann /s/ GARRETT MORRIS Director January 25, 1996 -------------------------------- Garrett Morris
II-3 EXHIBIT INDEX
EXHIBIT NUMBER EXHIBIT DESCRIPTION - --------- -------------------------------------------------------------------------------------------------------- 1.01 Form of underwriting Agreement between Surety Capital Corporation, Hoefer & Arnett, Incorporated and Anchorage Fire & Casualty Insurance Company, in Liquidation with respect to the firm commitment underwriting of shares of the Company's common stock and the shares owned by Anchorage Fire & Casualty Insurance Company, in Liquidation.* 2.01 Reorganization Agreement by and between Bancwell Financial Corp; Dan W. Brent, Jody Person and Joe M. Pearson; Texas Bank, N.A.; and Surety Capital Corporation dated July 23, 1992; and Agreement to Merge Bank of East Texas with and into Texas Bank, N.A. under the Charter of Texas Bank, N.A. and under the Title of Texas Bank, N.A., dated July 23, 1992. (4) 2.02 Reorganization Agreement by and between Newell Bancshares, Inc.; Dan W. Brent, Jody Pearson and Joe M. Pearson; Texas Bank, N.A.; and Surety Capital Corporation, dated July 23, 1992; and Agreement to Merge First State Bank with and into Texas Bank, N.A. under the Charter of Texas Bank, N.A. and under the Title of Texas Bank, N.A., dated July 23, 1992. (4) 2.03 Reorganization Agreement by and between The Farmers Guaranty State Bank of Kennard; Dr. Frank A. Smith, III; Surety Bank, National Association; and Surety Capital Corporation, dated February 4, 1994; and Agreement to Merge The Farmers Guaranty State Bank of Kennard with and into Surety Bank, National Association under the Charter of Surety Bank, National Association and under the title of Surety Bank, National Association, dated February 4, 1994. (6) 2.04 Reorganization agreement by and between First National Bank, N.A.; Lloyd W. Butts; D.C. Deegan; Norman Denton; Murriel Gilbreath; Robert S. Light; Joe B. Turner, Jr. (the "Shareholders"); Surety Bank, National Association; and Surety Capital Corporation; dated May 24, 1994; and Agreement to Merge between Surety Bank, National Association, First National Bank and Joined in by the Shareholders and Surety Capital Corporation, dated May 24, 1994. (7) 2.05 Reorganization Agreement by and between First Midlothian Corporation, First National Bank, N.A., certain individual shareholders and directors of First Midlothian Corporation, Surety Bank, National Association, and Surety Capital Corporation dated October 17, 1995; and form of Amendment Number One thereto.*** 2.06 Agreement to Merge Surety Acquisition, Inc. with and into First Midlothian Corporation Under the Charter of First Midlothian Corporation and Under the Title of First Midlothian Corporation between First Midlothian Corporation; Surety Acquisition, Inc.; and joined in by Surety Bank, National Association and the directors of First Midlothian Corporation and First National Bank, dated October 17, 1995.*** 2.07 Form of Agreement to Consolidate First National Bank and Surety Bank, National Association under the Charter of Surety Bank under the Charter of Surety Bank, National Association and under the Title of Surety Bank, National Association between Surety Bank, National Association and First National Bank and joined in by Surety Acquisition, Inc. and Surety Capital Corporation, dated October 17, 1995.*** 3.01 Certificate of Incorporation of the Company. (1) 3.02 Amendment to the Certificate of Incorporation, dated April 8, 1987. (2) 3.03 Certificate of Amendment to the Company's Certificate of Incorporation, as filed with the Delaware Secretary of State on April 4, 1988. (3) 3.04 Certificate of Designations Establishing Series of Shares of Preferred Stock, as filed with the Delaware Secretary of State on April 4, 1988. (3) 3.05 Certification of Elimination of Series of Shares of Preferred Stock of the Company as filed with the Delaware Secretary of State on January 31, 1992. (5) 3.06 Certificate of Amendment to Company's Certificate of Incorporation as filed with Delaware Secretary of State on June 14, 1993. (6) 3.07 Form of Common Stock certificate (specimen). (6) 3.08 Restated Bylaws of the Company. (8)
EXHIBIT NUMBER EXHIBIT DESCRIPTION - --------- -------------------------------------------------------------------------------------------------------- 5.01 Opinion of Secore & Waller, L.L.P. with respect to the validity of the shares to be registered and issued.** 10.01 Pledge Agreement by and between Surety Capital Corporation and Overton Bank and Trust, N.A., dated December 9, 1994. (9) 10.02 Guaranty Agreement entered into by C. Jack Bean with Overton Bank and Trust, N.A. with respect to the repayment by Surety Capital Corporation of loan from Overton Bank and Trust, N.A., dated December 9, 1994. (9) 10.03 Uniform Commercial Code Financing Statement UCC-1 completed with respect to Overton Bank & Trust, N.A.'s security interest in the Shares of Stock of Surety Bank, N.A., owned by Surety Capital Corporation. (9) 10.04 Promissory Note in the original principal amount of $500,000.00 with Surety Capital Corporation as borrower and Overton Bank and Trust, N.A. as lender with maturity date of June 23, 1996, dated June 23, 1995; and related Security Agreement (collateral Pledge Agreement) dated June 23, 1995. *** 10.05 Surety Capital Corporation 1988 Incentive Stock Option Plan of Surety. (5) 10.06 Form of Change in Control Agreement dated August 16, 1994, as entered into between the Company and C. Jack Bean with schedule identifying parties to substantially similar agreements. (8) 10.07 Lease agreement between Precinct Campus, Inc., as landlord, and Surety Capital Corporation, as tenant, regarding offices located in Hurst, Texas, dated February 14, 1994. (6) 10.08 Surety Capital Corporation 1995 Incentive Stock Option Plan. (8) 10.09 Form of Executive Deferred Compensation Agreement and related Adoption Agreement entered into between Surety Capital Corporation and Bobby W. Hackler and G.M. Heinzelmann, III, dated August 15, 1995.*** 10.10 Form of Letter Agreements between Surety Capital Corporation and Bobby W. Hackler and G. M. Heinzelmann, III, regarding the provision by the Company of term life insurance coverage, dated August 15, 1995.*** 21.01 Subsidiaries of the Registrant.*** 23.01 Consent of Coopers & Lybrand, L.L.P. with respect to the use of its January 27, 1995 Report.*** 23.02 Consent of Samson, Robbins & Associates, P.L.L.C. with respect to the use of its November 1, 1995 Report.*** 23.03 Consent of Secore & Waller, L.L.P.**
- ------------------------ (1) Filed with Registration Statement No. 33-1983 on Form S-1 and incorporated by reference herein. (2) Filed with the Company's Form 10-K dated October 31, 1987 and incorporated by reference herein. (3) Filed with the Company's Form 10-Q for the quarter ended April 30, 1988 and incorporated by reference herein. (4) Filed with Registration Statement No. 33-44893 on Form S-3 and incorporated by reference herein. (5) Filed with the Company's Form 10-K dated December 31, 1991 and incorporated by reference herein. (6) Filed with the Company's Form 10-K dated December 31, 1993 and incorporated by reference herein. (7) Filed with the Company's Form 8-K dated December 8, 1994 and incorporated by reference herein. (8) Filed with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994 and incorporated by reference herein. (9) Filed with Registration Statement No. 33-89264 on Form S-2 and incorporated by reference herein. * Filed herein. ** To be filed. *** Filed previously. EX-1.1 2 EXHIBIT 1.1 =============================================================================== SURETY CAPITAL CORPORATION 2,100,000 SHARES* COMMON STOCK ______________ UNDERWRITING AGREEMENT ______________ ______________, 1996 =============================================================================== *Plus an option to purchase from the Company up to 288,759 additional shares to cover over allotments. SURETY CAPITAL CORPORATION 2,100,000 SHARES COMMON STOCK* UNDERWRITING AGREEMENT _____________, 1996 Hoefer & Arnett Incorporated 353 Sacramento Street, 10th Floor San Francisco, California 94111 Ladies and Gentlemen: SECTION 1. INTRODUCTORY. Surety Capital Corporation, a Texas corporation (the "COMPANY"), proposes to issue and sell 1,925,061 shares ("PRIMARY SHARES") of its authorized but unissued Common Stock, par value $.10 per share ("COMMON STOCK"), and Anchorage Fire and Casualty Insurance Company, in Liquidation ("SELLING SHAREHOLDER") proposes to sell 174,939 shares of Common Stock ("SECONDARY SHARES"), to Hoefer & Arnett Incorporated ("UNDERWRITER"). In addition, the Company proposes to grant to the Underwriter an option to purchase up to 288,739 additional shares of Common Stock ("ADDITIONAL SHARES") as provided in Section 5 hereof. The Primary Shares and the Secondary Shares are referred to herein as the "FIRM SHARES;" the Firm Shares and, to the extent such option is exercised, the Additional Shares, are hereinafter collectively referred to as the "SHARES." You have advised the Company that you propose to make a public offering of the Shares as soon as you deem advisable after the registration statement hereinafter referred to becomes effective, if it has not yet become effective, and the Pricing Agreement hereinafter defined has been executed and delivered. _______________ * Plus an option to acquire up to 288,739 additional shares to cover over allotments. Prior to the purchase and public offering of the Shares by the Underwriter, the Company, the Selling Shareholder and the Underwriter shall enter into an agreement substantially in the form of Exhibit A hereto ("PRICING AGREEMENT"). The Pricing Agreement may take the form of an exchange of any standard form of written telecommunication between the Company, the Selling Shareholder and the Underwriter and shall specify such applicable information as is indicated in Exhibit A hereto. The offering of the Shares will be governed by this Agreement, as supplemented by the Pricing Agreement. From and after the date of the execution and delivery of the Pricing Agreement, this Agreement shall be deemed to incorporate the Pricing Agreement. The Company and the Selling Shareholder hereby confirm their agreements with respect to the purchase of the Shares by the Underwriter as follows: SECTION 2. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company represents and warrants to the Underwriter that: (a) A registration statement on Form S-1 (File No. 33-_______) and a related preliminary prospectus with respect to the Shares have been prepared and filed with the Securities and Exchange Commission ("COMMISSION") by the Company and in conformity with the requirements of the Securities Act of 1933, as amended, and the rules and regulations of the Commission thereunder (collectively, the "1933 ACT;" all references herein to specific rules are rules promulgated under the 1933 Act); and the Company has so prepared and has filed such amendments thereto, if any, and such amended preliminary prospectuses as may have been required to the date hereof. In the event that the Company determines to rely upon Rule 430A, the Company will prepare and file a prospectus pursuant to Rule 424(b) that discloses the information previously omitted from the prospectus in reliance upon Rule 430A. There have been or will promptly be delivered to you two signed copies of such registration statement and amendments, including the exhibits filed therewith, and such number of conformed copies of such registration statement and amendments (but without exhibits) and of the related preliminary prospectus or prospectuses and final forms of prospectus as the Underwriter may reasonably request. The registration statement and prospectus, as amended, on file with the Commission at the time the registration statement became or becomes effective, including the information deemed to be part of the registration statement at the time of effectiveness pursuant to Rule 430A(b), are hereinafter called the "REGISTRATION STATEMENT" and the "PROSPECTUS," respectively, except that if the prospectus filed by the Company pursuant to Rule 424(b) differs from the prospectus on file at the time the Registration Statement became or becomes effective, the term "PROSPECTUS" shall refer to the Rule 424(b) prospectus from and after the time it is filed with the Commission or transmitted to the Commission for filing. -2- The Securities Exchange Act of 1934, as amended, and the rules and regulations of the Commission thereunder are hereinafter collectively referred to as the "EXCHANGE ACT." (b) The Commission has not issued any order preventing or suspending the use of any preliminary prospectus, and each preliminary prospectus has conformed in all material respects with the requirements of the 1933 Act and, as of its date, has not included any untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein not misleading in light of the circumstances under which they were made. When the Registration Statement became or becomes effective, and at the First Closing Date and the Second Closing Date hereinafter defined, as the case may be, the Registration Statement, including the information deemed to be part of the Registration Statement at the time of effectiveness pursuant to Rule 430A(b), and the Prospectus and any amendments or supplements thereto, in all material respects conformed or will in all material respects conform to the requirements of the 1933 Act, and neither the Registration Statement nor the Prospectus, nor any amendment or supplement thereto, included or will include any untrue statement of a material fact or omitted or will omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that the Company makes no representation or warranty as to information contained in or omitted from any preliminary prospectus, the Registration Statement, the Prospectus or any such amendment or supplement in reliance upon and in conformity with written information furnished to the Company by or on behalf of the Underwriter specifically for use in the preparation thereof. (c) The Company and each of its subsidiaries, and First Midlothian Corporation, a Texas corporation ("FIRST MIDLOTHIAN"), and each of its subsidiaries, including, without limitation, Midlothian Bank, National Association ("MIDLOTHIAN BANK"), have been duly incorporated and are validly existing as corporations or banks in good standing under the laws of their respective jurisdictions of incorporation, with full power and authority to own or lease their properties and conduct their businesses as described in the Prospectus; the Company's only subsidiaries are those listed on Exhibit 22 of the Registration Statement; the Company and each of its subsidiaries, and First Midlothian and each of its subsidiaries, are duly qualified to do business as foreign corporations under the corporation law of, and are in good standing as such in, each jurisdiction in which they own or lease substantial properties, have an office, or in which substantial business is conducted and such qualification is required except in any such case where the failure to so qualify or be in good standing would not have a material adverse effect upon the condition (financial or otherwise), earnings, affairs, business or prospects of the Company and its subsidiaries, or First Midlothian and its subsidiaries, as the case may be, taken as a whole ("MATERIAL ADVERSE EFFECT"); and no proceeding of which the Company has knowledge has been instituted in any such jurisdiction, revoking, limiting or curtailing, or seeking to revoke, limit -3- or curtail, such power and authority or qualification. Surety Bank and Midlothian Bank are referred to herein as the "Banks." (d) The Company has an authorized and outstanding capitalization as set forth in the Prospectus under "Capitalization" and the Shares conform in all material respects to the description thereof contained in the Prospectus. All of the issued and outstanding shares of Common Stock have been duly authorized, validly issued and are fully paid and non-assessable and free of preemptive or other similar rights and there are no options, agreements, contracts or other rights in existence to acquire from the Company any shares of Common Stock, except as set forth in the Prospectus. Except as set forth in the Prospectus, there are no holders of the securities of the Company having rights to the registration thereof. The Company and First Midlothian have no banking subsidiaries other than Surety Bank and Midlothian Bank, respectively. All of the capital stock of each subsidiary of the Company and each subsidiary of First Midlothian other than the Banks has been duly authorized, validly issued and is fully paid and non-assessable. All of the outstanding capital stock of each of the Banks has been duly authorized, validly issued and is fully paid and, subject to 12 U.S.C. Section 55 (1982), nonassessable. Each of the Company and First Midlothian, directly or indirectly, owns of record and beneficially, free and clear of any liens, claims, encumbrances or rights of others, all of the issued and outstanding shares of each of its respective subsidiaries, except as referred to in the Prospectus. There are no options, agreements, contracts or other rights in existence to purchase or acquire from the Company or its subsidiaries, or First Midlothian or its subsidiaries, any issued and outstanding shares of the capital stock of such subsidiaries. (e) The Primary Shares to be sold by the Company pursuant to this Agreement and the Pricing Agreement have been duly authorized and, when issued and paid for in accordance with this Agreement and the Pricing Agreement, will be validly issued, fully paid and non-assessable; the Secondary Shares to be sold by the Selling Shareholder are duly authorized, validly issued, fully paid and non-assessable; the Shares are not subject to the preemptive rights of any shareholder of the Company; the holders of the Shares will not be subject to personal liability by reason of being such holders; and all corporate actions required to be taken for the authorization, issue and sale of the Primary Shares have been validly and sufficiently taken. (f) The execution, delivery and performance by the Company of this Agreement and the Pricing Agreement have been duly authorized by all necessary corporate action on the part of the Company and do not and will not violate any provision of the Company's articles of incorporation (as amended) or bylaws (as amended) and do not and will not constitute or result in the breach of, or be in violation of, any of the terms or provisions of or constitute a default under, or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company or its subsidiaries under -4- any material agreement, franchise, license, indenture, lease, mortgage, deed of trust, or other instrument to which the Company or any subsidiary is a party or by which the Company, any subsidiary or the property of any of them may be bound or affected, or any law, order, judgment, decree, rule or regulation applicable to the Company or any subsidiary of any government, governmental instrumentality, court or regulatory body, administrative agency, or other governmental body having jurisdiction over the Company or any subsidiary or any of their respective properties, or any order of any court or governmental agency or other regulatory authority entered in any proceeding to which the Company or any subsidiary was or is now a party or by which it is bound. No consent, approval, authorization or other order of or filing with, any court, regulatory body, administrative agency or other governmental body is legally required for the execution and delivery of this Agreement or the Pricing Agreement by the Company or the consummation by the Company of the transactions contemplated herein or therein, except as may be required under or by the 1933 Act, the Amex or the blue sky laws of the various jurisdictions. This Agreement and the Pricing Agreement have been duly authorized, executed and delivered by the Company and constitute valid and binding obligations of the Company enforceable against the Company in accordance with their terms except insofar as (i) such enforcement may be subject to bankruptcy, insolvency, reorganization, moratorium or other laws now or hereafter in effect relating to creditors' rights generally; (ii) the remedy of specific performance and injunctive and other forms of equitable relief may be subject to equitable defenses and to the discretion of the court before which any proceeding thereafter may be brought; and (iii) such enforcement may be subject to any limitations under applicable law which relate to the indemnification and contribution provisions of this Agreement. (g) Each of Coopers & Lybrand LLP and Samson, Robbins & Associates, P.L.L.C., who have expressed their opinion with respect to certain of the financial statements included in the Registration Statement, are independent accountants within the meaning of the 1933 Act. (h) The consolidated financial statements, together with the notes thereto, of the Company and First Midlothian included in the Registration Statement comply in all material respects with the 1933 Act and present fairly the consolidated financial position of the Company and First Midlothian, respectively, as of the respective dates of such financial statements (including, without limitation, the allowance for possible loan losses), and the consolidated results of operations and cash flows of the Company and First Midlothian for the respective periods covered thereby, all in conformity with generally accepted accounting principles consistently applied throughout the periods involved, except as disclosed in the Prospectus; and the supporting schedules included in the Registration Statement present fairly the information required to be stated therein. No other Financial statements are required to be included in the Registration Statement. The consolidated financial, statistical and numerical information with respect to the Company and its subsidiaries, and the financial -5- and statistical information with respect to Surety Bank, set forth in the Prospectus are fairly presented, were derived from the consolidated financial statements or the books and records of the Company and its subsidiaries and are prepared on a basis consistent with the audited financial statements of the Company. (i) The PRO FORMA financial information of the Company and its subsidiaries included in the Registration Statement presents fairly the information shown therein; has been compiled on a basis consistent with that of the audited consolidated financial statements of the Company and its subsidiaries and of First Midlothian and its subsidiaries included in the Registration Statement; has been prepared in accordance with the Commission's rules and guidelines with respect to PRO FORMA financial statements; and the assumptions used in the preparation thereof are reasonable. (j) Neither the Company nor any subsidiary thereof, nor either First Midlothian or any subsidiary thereof, is in violation of its articles of incorporation, articles of association, or bylaws, in each case as amended, or in default under any consent decree, formal agreement, memorandum of understanding or similar agreement, or in default with respect to any provision of any lease, loan agreement, franchise, license, permit or other contractual obligation to which it is a party or by which it or any of its properties may be bound; there does not exist any state of facts which constitutes an event of default by the Company as defined in such documents or which, with notice or lapse of time or both, would constitute such an event of default, except for any such violation or default of the articles of incorporation, articles of association, bylaws, consent decrees, formal agreements, memoranda of understanding or similar agreements, or any lease, loan agreement, franchise, license, permit or other contractual obligations referred to in this subparagraph (j) which, either individually or in the aggregate, would not have a Material Adverse Effect. (k) Except as disclosed in the Prospectus, (A) there is no action, suit or proceeding before or by any court or governmental or regulatory agency or body, domestic or foreign, or any arbitrator or arbitration panel, now pending or, to the knowledge of the Company, threatened against or affecting the Company or any of its subsidiaries, or First Midlothian or any of its subsidiaries, including without limitation proceedings relating to discrimination or environmental matters, which could result in a Material Adverse Effect, and (B) there is no decree, judgment, order, formal agreement or memorandum of understanding of any kind in existence applicable to the Company or any of its subsidiaries, or First Midlothian or any of its subsidiaries, or any of their respective officers, employees or directors, requiring or restraining the taking of any actions of any kind in connection with the business of the Company and its subsidiaries or First Midlothian or its subsidiaries, respectively. -6- (l) Each of the Company and First Midlothian is a bank holding company duly registered with the Board of Governors of the Federal Reserve System ("FEDERAL RESERVE BOARD") under the Bank Holding Company Act of 1956, as amended. Each Bank is a national bank duly chartered and organized by authority of the Office of the Comptroller of the Currency ("OCC"). The deposit accounts of each Bank are insured by the Federal Deposit Insurance Corporation through the Bank Insurance Fund to the fullest extent permitted by law, and all premiums and assessments required in connection therewith have been paid by such Bank. Since January 1, 1991, the Company and each Bank has filed all material reports and amendments thereto that they were required to file with the Federal Reserve Board, the OCC and any other federal or state regulatory authorities. Except as set forth in the Prospectus, there is no unresolved material violation, criticism or exception by any governmental or regulatory agency with respect to any report or statement relating to any examinations of the Company or any of its subsidiaries. The conduct of the business of the Company and each of its subsidiaries is in compliance in all respects with applicable federal, state, local and foreign laws and regulations, and all formal agreements, memoranda of understanding and similar agreements with regulatory authorities, except where the failure to be in compliance would not have a Material Adverse Effect. Each of the Company and its subsidiaries, and each of First Midlothian and its subsidiaries, own or possess or have obtained all governmental licenses, permits, consents, orders, approvals and other authorizations necessary to lease or own, as the case may be, and to operate their properties and to carry on their businesses as presently conducted except where the failure to have any such governmental licenses, permits, consents, orders, approvals and other authorizations would not have a Material Adverse Effect. Neither the Company nor any of its subsidiaries, nor First Midlothian or any of its subsidiaries, has received any written notice of proceedings related to revocation or modification of any such licenses, permits, consents, orders, approvals or authorizations which singly or in the aggregate, if the subject of an unfavorable ruling or finding, would result in a Material Adverse Effect. Except as disclosed in the Prospectus, none of the Company, First Midlothian or the Banks is currently a party or subject to any agreement or memorandum with, or directive or order issued by, the Federal Reserve Board, the OCC or any other federal or state regulatory authorities, which imposes any material restrictions or requirements not generally applicable to bank holding companies or commercial banks. (m) Each of the Company and its subsidiaries, and each of First Midlothian and its subsidiaries, have valid and indefeasible title to all of the properties and assets reflected as owned by them in the financial statements hereinabove described (or described elsewhere in the Prospectus), subject to no lien, mortgage, pledge, charge, encumbrance or title defect of any kind except those, if any, reflected in such financial statements (or described elsewhere in the Prospectus) or which are not material to the Company and its subsidiaries, or First Midlothian and its subsidiaries, as the case may be, taken as a whole. Each of the Company and its subsidiaries, and each of First Midlothian -7- and its subsidiaries, hold their respective leased properties that are material to the Company and its subsidiaries, or First Midlothian and its subsidiaries, respectively, taken as a whole under valid and binding leases. (n) None of the Company or its subsidiaries, and none of First Midlothian or its subsidiaries, has taken, and none will take, directly or indirectly, any action designed to or which has constituted or which might reasonably be expected to cause or result, under the Exchange Act or otherwise, in stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Shares. (o) Since the respective dates as of which information is given in the Registration Statement and the Prospectus, except as otherwise stated or contemplated therein, there has not been (i) any material adverse change in the condition (financial or otherwise), earnings, affairs, business or prospects of the Company or its subsidiaries, or of the earnings, affairs, business or prospects of First Midlothian or its subsidiaries, whether or not arising in the ordinary course of business, (ii) any material transaction entered into, or any material liability or obligation incurred, by the Company or its subsidiaries or by First Midlothian or its subsidiaries other than in the ordinary course of business, (iii) any change in the capital stock, or increase in the short-term debt or long-term debt of the Company or its subsidiaries or of First Midlothian or its subsidiaries, or (iv) any dividend or distribution of any kind declared, paid or made by the Company or First Midlothian in respect of its capital stock. (p) There are no contracts or other documents required to be described in the Registration Statement or to be filed as exhibits to the Registration Statement by the 1933 Act which have not been described or filed as required. The contracts so described in the Prospectus are in full force and effect on the date hereof; and neither the Company nor any of the subsidiaries, nor to the knowledge of the Company, and other party, is in breach of or default under any of such contracts. (q) The Company together with its subsidiaries, and First Midlothian together with its subsidiaries, owns and possesses sufficient right, title and interest in and to, or has duly licensed from third parties the right to use, all trademarks, trade names, copyrights and other proprietary rights ("TRADE RIGHTS") material to the business of the Company and each of its subsidiaries, or First Midlothian and its subsidiaries, in each case taken as a whole. None of the Company or any of its subsidiaries or First Midlothian or any of its subsidiaries has received any written notice of infringement, misappropriation or conflict from any third party as to such material Trade Rights which has not been resolved or disposed of, and none of the Company or any of its subsidiaries, or First Midlothian or any of its subsidiaries, has infringed, misappropriated or otherwise conflicted with material -8- Trade Rights of any third parties, which infringement, misappropriation or conflict would have a Material Adverse Effect. (r) All offers and sales of equity securities prior to the date hereof by the Company, First Midlothian or any of their respective subsidiaries were at all relevant times either exempt from the registration requirements of the 1933 Act and the registration requirements of all applicable state securities or blue sky laws, or were duly registered in accordance with the provisions thereof. (s) Each of the Company and its subsidiaries, and each of First Midlothian and its subsidiaries, has timely filed all necessary federal and state income and franchise tax returns required to be filed through the date hereof and have paid all taxes shown as due thereon, and there is no tax deficiency that has been, or to the knowledge of the Company might reasonably be expected to be, asserted against the Company or any of its subsidiaries or any of their properties or assets, or against First Midlothian or any of its subsidiaries or any of their properties or assets, that could reasonably be expected to have a Material Adverse Effect. (t) The Company's Common Stock is registered pursuant to Section 12(b) of the Exchange Act, and listed for trading on the American Stock Exchange, Inc. ("AMEX"). The Company has filed an additional listing application with the Amex with respect to the Primary Shares, and has received notification from the Amex that the listing of the Primary Shares has been approved, subject to notice of issuance or sale thereof. (u) Neither the Company nor any of its subsidiaries (and neither First Midlothian nor any of its subsidiaries) is, and neither the Company nor any of its subsidiaries intends to conduct its business in a manner in which it would become, an "investment company" within the meaning of the Investment Company Act of 1940, as amended. (v) No labor dispute with the employees of the Company or any of its subsidiaries, or with the employees of First Midlothian and its subsidiaries, is pending or, to the knowledge of the Company, threatened that could reasonably be expected to have a Material Adverse Effect. Each employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), for which the Company or any subsidiary, or for which First Midlothian or any subsidiary, acts as sponsor within the meaning of ERISA is and has been in all material respects operated and administered in accordance with the provisions of ERISA and applicable law. The present value of all benefits vested under each employee benefit plan which is subject to Title IV of ERISA did not exceed, as of the end of the most recent plan year, the value of the assets of the plan allocable to such vested or accrued benefits, and no such plan or any trust created thereunder has incurred any "accumulated funding deficiency" within the meaning of the Internal -9- Revenue Code ("CODE") since the effective date of ERISA. No employee benefit plan or any trust created thereunder or any trustee fiduciary or administrator thereof has engaged in a "prohibited transaction" within the meaning of the Code or ERISA or violated any of the fiduciary standards of ERISA, and there has been no "reportable event" within the meaning of ERISA with respect to any such plan. (w) Each of the Company and its subsidiaries, and each of First Midlothian and its subsidiaries, (A) makes and keeps books, records and accounts which, in reasonable detail and in all material respects, accurately and fairly reflect its transactions and dispositions of its assets and (B) maintains a system of internal accounting controls sufficient to provide reasonable assurance that (1) transactions are executed in accordance with management's general or specific authorizations, (2) transactions are recorded as necessary (i) to permit the preparation of financial statements in conformity with generally accepted accounting principles consistently applied or any other criteria applicable to such statements and (ii) to maintain accountability for assets, (3) access to assets is permitted only in accordance with management's general or specific authorizations and (4) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (x) Except as disclosed in the Prospectus, (A) none of the Company, First Midlothian or any of their respective subsidiaries is presently engaged in negotiations for the acquisition of all or a portion of the stock or other equity interest or all or a portion of the assets of any person (including without limitation any company, corporation, partnership, limited liability company, partnership, joint venture or sole proprietorship), and (B) has no agreements or understandings with respect to the acquisition of all or a portion of the stock or other equity interest or all or portion of the assets of any specific person. (y) Except as disclosed in the Prospectus, as of the date of the Prospectus and as of each Closing Date, (A) no extension of credit made by either Bank to an executive officer, director, or affiliate of the Company, First Midlothian or either of the Banks is (1) delinquent, past due, on non- accrual status or non-performing, (2) identified as a potential problem loan on any internal "watch list" or (3) constitutes a restructured loan; and (B) all extensions of credit to any director or executive officer or any member of their immediate family (1) were made in the ordinary course of business, (2) were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and (3) did not involve more than the normal risk of collectibility or present other unfavorable features. (z) That certain Reorganization Agreement dated October 17, 1995 among First Midlothian, Midlothian Bank, the directors of Midlothian Bank in their individual and representative capacities and the Company covering the transactions between -10- the Company, First Midlothian and Midlothian Bank described in the Prospectus under the caption "The Midlothian Bank Acquisition -- The Reorganization Agreement" and the transactions contemplated thereby have been authorized by all necessary corporate action on the part of the Company, been executed and delivered by the Company and the other parties thereto and constitutes a valid and binding obligation of the Company (assuming the due authorization, execution and delivery thereof by the other parties thereto) enforceable against the Company in accordance with its terms, except insofar as (i) such agreement may be subject to bankruptcy, insolvency, reorganization, moratorium or other laws relating to creditors' rights generally, and (ii) the remedy of specific performance and injunctive and other forms of equitable relief may be subject to equitable defenses and to the discretion of the court before which any proceeding thereafter may be brought. (aa) The Company intends to apply the net proceeds from the sale of the Primary Shares for the purposes set forth in the Prospectus under the caption "Use of Proceeds." (bb) Since January 1, 1991 the Company has, and at each Closing Date the Company will have, made all filings required to be made by it under the Exchange Act; and all such filings conformed and will conform in all material respects to the requirements of the Exchange Act, and none of such filings contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein, in lieu of the circumstances under which they were made, not misleading. (cc) The Company is not required to comply with Florida Statute Section 517.075. SECTION 3. REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE SELLING SHAREHOLDER. The Selling Shareholder represents and warrants to, and covenants and agrees with the Company and the Underwriter, that: (a) The Selling Shareholder has placed in custody under a Custody Agreement dated a date prior to the date hereof ("Custody Agreement") with ___________________ Bank, as Custodian ("Custodian"), for delivery under this Agreement, certificates in negotiable form representing the Secondary Shares to be sold by the Selling Shareholder hereunder. The Selling Shareholder specifically agrees that the Secondary Shares represented by the certificates so held in custody for such Selling Shareholder are subject to the interests of the Underwriter hereunder, that the arrangements made by the Selling Shareholder for such custody are to that extent irrevocable and not subject to termination and that the obligations of the Selling Shareholder hereunder shall not be terminated by any act of the Selling Shareholder, by operation of law, or by the occurrence of any other event. -11- (b) All consents, approvals, authorizations and orders necessary for the execution and delivery by the Selling Shareholder of this Agreement, and for the sale and delivery of the Secondary Shares to be sold by the Selling Shareholder hereunder, have been obtained; and the Selling Shareholder has full right, power and authority to enter into this Agreement and to sell, assign, transfer and deliver the Shares to be sold by the Selling Shareholder hereunder. (c) This Agreement and the Custody Agreement have been duly authorized, executed and delivered by the Selling Shareholder and constitute valid and binding obligations of the Selling Shareholder enforceable against the Selling Shareholder in accordance with their terms except insofar as (i) the remedy of specific performance and injunctive and other forms of equitable relief may be subject to equitable defenses and to the discretion of the court before which any proceeding thereafter may be brought; and (ii) such enforcement may be subject to any limitations under applicable law which relate to the indemnification and contribution provisions of this Agreement. (d) The sale of the Secondary Shares to be sold by the Selling Shareholder hereunder and the compliance by the Selling Shareholder with all of the provisions of this Agreement and the consummation of the transactions herein contemplated will not conflict with or result in a breach or violation of any of the terms or provisions of, or constitute a default under, any statute, indenture, mortgage, deed of trust, loan agreement or other agreement or instrument to which the Selling Shareholder or any of its subsidiaries is a party or by which the Selling Shareholder or any of its subsidiaries is bound, or to which any of the property or assets of the Selling Shareholder or any of its subsidiaries is subject, nor will such action result in any violation of the provisions of the Certificate of Incorporation or By-laws of the Selling Shareholder or any of its subsidiaries or any statute or any order, rule or regulation of any court or governmental agency or body having jurisdiction over the Selling Shareholder or any of its subsidiaries or the property of the Selling Shareholder or any of its subsidiaries. (e) The Selling Shareholder has, and immediately prior to each Time of Delivery (as defined in Section 5 hereof) the Selling Shareholder will have, good and valid title to the Shares to be sold by the Selling Shareholder hereunder, free and clear of all liens, encumbrances, equities or claims; and, upon delivery of such Shares and payment therefor pursuant hereto, good and valid title to such Shares, free and clear of all liens, encumbrances, equities or claims, will pass to the Underwriter. (f) The information pertaining to the Selling Shareholder under the caption "Selling Shareholder" does not contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading. -12- (g) In order to document the Underwriter's compliance with the reporting and withholding provisions of the Tax Equity and Fiscal Responsibility Act of 1982 with respect to the transactions herein contemplated, such Selling Shareholder will deliver to you prior to or at the First Time of Delivery (as hereinafter defined) a properly completed and executed United States Treasury Department Form W-9 (or other applicable form or statement specified by Treasury Department regulations in lieu thereof). (h) Neither the Selling Shareholder nor any of its subsidiaries has taken, and none will take, directly or indirectly, any action designee to or which has constituted or which might reasonably be expected to cause or result, under the Exchange Act or otherwise, in stabilization or manipulation of the price of any security of the Company to facilitate its sale or resale of the Shares. (i) The Selling Shareholder agrees to cooperate to the extent reasonably necessary to cause the Registration Statement and any post-effective amendment thereto to become effective at the earliest possible time. The Selling Shareholder agrees to do or perform all things reasonably required to be done or performed by the Selling Shareholder prior to the First Closing Date to satisfy all conditions precedent to the delivery of and the payment for the Secondary Shares being sold by the Selling Shareholder pursuant to this Agreement. SECTION 4. REPRESENTATION AND WARRANTY OF THE UNDERWRITER. The Underwriter represents and warrants to the Company that the information set forth with respect to the Shares (a) on the cover page of the Prospectus with respect to price, underwriting discount and terms of the offering and (b) under "Underwriting" in the Prospectus constitutes the only information furnished to the Company by and on behalf of the Underwriter for use in connection with the preparation of the Registration Statement and such information is correct in all material respects. SECTION 5. PURCHASE, SALE AND DELIVERY OF SHARES. (a) On the basis of the representations, warranties and agreements herein contained, but subject to the terms and conditions herein set forth, the Company agrees to issue and sell to the Underwriter, and the Selling Shareholder agrees to sell to the Underwriter, and the Underwriter agrees to purchase from the Company and the Selling Shareholder, the Firm Shares. The purchase price per share to be paid by the Underwriter to the Company and the Selling Shareholder shall be the price per share set forth in the Pricing Agreement. Delivery of certificates for the Firm Shares to be purchased by the Underwriter and payment therefor shall be made at the offices of Hoefer & Arnett Incorporated, 353 Sacramento Street, 10th Floor, San Francisco, California (or such other place as may be agreed upon by the Company and the Underwriter) at such time and date, not later than the -13- third full business day following the first date that any of the Common Shares are released by you for sale to the public, as you shall designate by at least 48 hours prior notice to the Company (the "First Closing Date"); provided, however, that if the Prospectus is at any time prior to the First Closing Date recirculated to the public, the First Closing Date shall occur upon the later of the third full business day following the first date that any of the Common Shares are released by you for sale to the public or the date that is 48 hours after the date that the Prospectus has been so recirculated. Delivery of certificates for the Firm Shares shall be made by or on behalf of the Company and the Selling Shareholder to you, against payment by you of the purchase price therefor by certified or official bank checks payable in next day funds to the order of the Company and the Selling Shareholder. The certificates for the Firm Shares shall be registered in such names and denominations as you shall have requested at least two full business days prior to the First Closing Date, and shall be made available for checking and packaging on the business day preceding the First Closing Date at a location in New York, New York, as may be designated by you. Time shall be of the essence, and delivery at the time and place specified in this Agreement is a further condition to the obligations of the Underwriter. (b) In addition, on the basis of the representations, warranties and agreements herein contained, but subject to the terms and conditions herein set forth, the Company hereby grants an option to the Underwriter to purchase up to an aggregate of 288,759 additional Shares, at the same purchase price per share to be paid for the Firm Shares, for use solely in covering any over allotments made by the Underwriter in the sale and distribution of the Firm Shares. The option granted hereunder may be exercised at any time (but not more than once), in whole or in part, within 30 days after the date of the final Prospectus upon written notice by you to the Company setting forth the aggregate number of Additional Shares as to which the Underwriter is exercising the option, the names and denominations in which the certificates for such shares are to be registered and the time and place at which such certificates will be delivered. Such time of delivery (which may not be earlier than the First Closing Date), being herein referred to as the "SECOND CLOSING DATE," shall be determined by you, but if at any time other than the First Closing Date, shall not be earlier than three nor later than ten full business days after delivery of such notice of exercise. Certificates for the Additional Shares will be made available at the Company's expense for checking and packaging at 9:00 A.M., local time, on the first full business day preceding the Second Closing Date at a location in New York, New York as may be designated by you. The manner of payment for and delivery of the Additional Shares shall be the same as for the Firm Shares as specific in Section 5(a). (c) If the Company has elected not to rely upon Rule 430A, the initial public offering price of the Shares and the purchase price per share to be paid by the Underwriter -14- for the Shares shall have each been determined and set forth in the Pricing Agreement, dated the date hereof, and an amendment to the Registration Statement and the Prospectus will be filed before the Registration Statement becomes effective. (d) If the Company has elected to rely upon Rule 430A, the purchase price per share to be paid by the Underwriter for the Shares shall be an amount equal to the initial public offering price, less an amount per share to be determined by agreement between the Underwriter and the Company. The initial public offering price per share of the Shares shall be a fixed price to be determined by agreement between the Underwriter and the Company. The initial public offering price per share and the purchase price, when so determined, shall be set forth in the Pricing Agreement. In the event that such prices have not been agreed upon and the Pricing Agreement has not been executed and delivered by the parties thereto by the close of business on the second business day following the date of this Agreement, this Agreement shall terminate forthwith, without liability of any party to any other party, unless otherwise agreed to by the Company, the Selling Shareholder and the Underwriter. SECTION 6. COVENANTS OF THE COMPANY. The Company covenants and agrees with the Underwriter that: (a) The Company will use its best efforts to cause the Registration Statement to become effective. The Company will advise you promptly of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement (and make every reasonable effort to obtain the withdrawal of such order as early as possible) or of the institution of any proceedings for that purpose, or of any notification of the suspension of qualification of the Shares for sale in any jurisdiction or the initiation or threatening of any proceedings for that purpose, and will also advise you promptly of any request of the Commission for amendment or supplement of the Registration Statement, of any preliminary prospectus or of the Prospectus, or for additional information, and will not file any amendment or supplement to the Registration Statement, to any preliminary prospectus or to the Prospectus of which you have not been furnished with a copy prior to such filing or to which you reasonably object. (b) If at any time when a prospectus relating to the Shares is required to be delivered under the 1933 Act, any event occurs as a result of which the Prospectus, including any amendments or supplements, would include an untrue statement of a material fact, or omit to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, or if it is necessary at any time to amend the Prospectus, including any amendments or supplements thereto and including any revised prospectus which the Company proposes for use by the Underwriter in connection with the offering of the Shares which differs from the prospectus on file with the Commission at the time of effectiveness -15- of the Registration Statement, whether or not such revised prospectus is required to be filed pursuant to Rule 424(b) to comply with the 1933 Act, the Company promptly will advise you thereof and will promptly prepare and, if required pursuant to Rule 424(b), file with the Commission an amendment or supplement which will correct such statement or omission or an amendment which will effect such compliance. (c) Neither the Company nor any of its subsidiaries will, prior to the earlier of the Second Closing Date or termination or expiration of the related option, incur any material liability or obligation, direct or contingent, or enter into any material transaction, other than in the ordinary course of business, except as contemplated by the Prospectus. (d) The Company will not declare or pay any dividend or make any other distribution upon the Common Stock payable to shareholders of record on a date prior to the earlier of the Second Closing Date or termination or expiration of the related option, except as contemplated by the Prospectus. (e) Not later than 90 days after the close of the period covered thereby, the Company will make generally available to its security holders an earnings statement (which need not be audited) covering a period of at least 12 months beginning after the effective date of the Registration Statement, which will satisfy the provisions of the last paragraph of Section 11(a) of the 1933 Act and Rule 158 thereunder. (f) During such period as a prospectus is required by law to be delivered in connection with offers and sales of the Shares by an Underwriter or dealer, the Company will furnish to you at its expense (and consents to the use thereof), subject to the provisions of subsection (b) hereof, copies of the Registration Statement, the Prospectus, each preliminary prospectus and all amendments and supplements to any such documents in each case as soon as available and in such quantities as you may reasonably request, for the purposes contemplated by the 1933 Act. (g) The Company will cooperate with the Underwriters in qualifying or registering the Shares for sale under the blue sky laws of such jurisdictions as you designate, and will continue such qualifications in effect so long as reasonably required for the distribution of the Shares. The Company shall not be required to qualify as a foreign corporation or to file a general consent to service of process in any such jurisdiction where it is not currently qualified or where it would be subject to taxation as a foreign corporation. (h) During the period of three years after the date of the Pricing Agreement, the Company will furnish to the Representative a copy (i) as soon as practicable after the filing thereof, of each report filed by the Company with the Commission, any -16- securities exchange or the NASD and (ii) as soon as available, of each report of the Company mailed to any class of its securityholders. (i) The Company will use the net proceeds received by it from the sale of the Shares in the manner specified in the Prospectus under the caption "Use of Proceeds." (j) If, at the time of effectiveness of the Registration Statement, any information shall have been omitted therefrom in reliance upon Rule 430A, then immediately following the execution and delivery of the Pricing Agreement, the Company will prepare, and file or transmit for filing with the Commission in accordance with such Rule 430A and Rule 424(b), copies of an amended prospectus, or, if required by such Rule 430A, a post-effective amendment to the Registration Statement (including an amended prospectus), containing all information so omitted. (k) The Company will file with the Commission in a timely manner all reports on Form SR required by Rule 463 and will furnish you copies of any such reports as soon as practicable after the filing thereof. (l) The Company will comply with all of the provisions of each undertaking contained in the Registration Statement. (m) The Company will not, without the prior written consent of the Underwriter, sell, contract to sell or otherwise dispose of any equity security of the Company (including shares of Common Stock) for a period of 180 days after the effective date of the Registration Statement, other than (i) Common Stock issued and sold to the Underwriter pursuant to this Agreement, and (ii) Common Stock issued upon exercises of outstanding stock options granted under the Company's 1988 Stock Option Plan or 1995 Stock Option Plan (as such terms are defined in the Prospectus) in the aggregate not to exceed ____ shares of Common Stock. The Company will cause each of its executive officers and directors to deliver to the Underwriter on or before the date of this Agreement an agreement satisfactory in form and substance to the Underwriter and its counsel, whereby each agrees, for a period of 180 days after the effective date of the Registration Statement, not to offer, sell or otherwise dispose of any shares of Common Stock without the prior written consent of the Underwriter ("Lock-Up Letter"). SECTION 7. PAYMENT OF EXPENSES. (a) The Company will pay, or reimburse if paid by the Underwriter, whether or not the transactions contemplated hereby are consummated or this Agreement is terminated, all costs and expenses incident to the performance by the Company of its obligations under this Agreement and the Pricing Agreement, including, without limiting the generality of the foregoing, (i) preparation, printing, filing and distribution (including postage, air freight charges and charges for counting and packaging) -17- of the Registration Statement, each preliminary prospectus, the Prospectus, each amendment and/or supplement to any of the foregoing, and this Agreement and the Selected Dealers Agreement; (ii) the furnishing to the Underwriter and dealers copies of the foregoing materials (provided, however, that any such copies furnished by the Company more than nine months after the first date upon which the Shares are offered to the public shall be at the expense of the Underwriter or dealer so requesting as provided in paragraphs 6(b) above); (iii) the registrations or qualification referred to in paragraph 6(g) above (including reasonable fees and disbursements of counsel in connection therewith) and expenses of printing and delivering to the Underwriter copies of the preliminary and final Blue Sky memoranda, provided that in no event shall the Company be required to pay in excess of $15,000 with respect to the fees, disbursements and expenses referred to in this clause (iii), exclusive of filing fees; (iv) the review of the terms of the public offering of the Shares by the NASD (including the filing fees paid to the NASD in connection therewith); (v) the performance by the Company of its other obligations under this Agreement, including the fees of the Company's counsel and accountants; (vi) the issuance of the Shares and the preparation and printing of the stock certificates representing the Shares including any stamp taxes payable in connection with the original issuance of the Shares; and (vii) furnishing to the Representative copies of all reports and information required by Section 6(h) above, including costs of shipping and mailing; PROVIDED, however, that except in the circumstances described in the following paragraph, the aggregate amount of costs and expenses of the Underwriter reimbursed hereunder shall not exceed two percent (2%) of the proposed maximum aggregate offering price set forth on the facing page of the Registration Statement. (b) If the sale to the Underwriter of the Firm Shares on the First Closing Date is not consummated because (i) this Agreement is terminated by the Underwriter in accordance with the provisions of Section 11(i) hereof, (ii) any condition of the Underwriter's obligations hereunder is not satisfied, (ii) of any refusal, inability or failure on the part of the Company to perform any agreement herein or to comply with any provision hereof (unless such failure to satisfy such condition or to comply with any provision hereof is due to the default or omission of the Underwriter), the Company agrees to reimburse you upon demand for all out-of-pocket expenses (including reasonable fees and disbursements of counsel) that shall have been reasonably incurred by you and them in connection with the proposed purchase and the sale of the Shares. (c) The provisions of this Section 7 shall not affect any agreement between the Company and the Selling Shareholder regarding the allocation or sharing of the expenses and costs of the public offering and sale of the Shares. Moreover, the execution, delivery and performance of this Agreement by the Liquidator (as that term is defined in the Prospectus) is without prejudice to any claim the Liquidator has or may have against Surety Bank or the Company. -18- SECTION 8. CONDITIONS OF THE OBLIGATIONS OF THE UNDERWRITER. The obligations of the Underwriter to purchase and pay for the Firm Shares on the First Closing Date and the Additional Shares on the Second Closing Date shall be subject to the accuracy in all material respects of the representations and warranties on the part of the Company and the Selling Shareholder herein set forth as of the date hereof and as of the First Closing Date and the Second Closing Date, as the case may be, to the accuracy of the statements of the Company and the Selling Shareholder made pursuant to the provisions hereof, to the performance in all material respects by the Company and the Selling Shareholder of their respective obligations hereunder, and to the following additional conditions: (a) The Registration Statement shall have become effective either prior to the execution of this Agreement or not later than 5:00 P.M., Eastern Time, on the first full business day after the date of this Agreement, or such later time as shall have been consented to by you but in no event later than 5:00 P.M., Eastern Time, on the third full business day following the date hereof; and prior to the First Closing Date or the Second Closing Date, as the case may be, no stop order suspending the effectiveness of the Registration Statement shall have been issued and no proceedings for that purpose shall have been instituted or shall be pending or, to the knowledge of the Company or you, shall be contemplated by the Commission. If the Company has elected to rely upon Rule 430A, the information concerning the initial public offering price of the Securities and price-related information shall have been transmitted to the Commission for filing pursuant to Rule 424(b) within the prescribed period and the Company will provide evidence satisfactory to the Representative of such timely filing (or a post-effective amendment providing such information shall have been filed and declared effective in accordance with the requirements of Rules 430A and 424(b)). (b) The Shares shall have been qualified for sale under the blue sky laws of such states as shall have been specified by you. (c) The legality and sufficiency of the authorization, issuance and sale of the Shares hereunder, the validity and form of the certificates representing the Shares, the execution and delivery of this Agreement, the Pricing Agreement, and all corporate proceedings and other legal matters incident thereto, and the form of the Registration Statement and the Prospectus (except financial statements) shall have been approved by your counsel. (d) Subsequent to the execution and delivery of this Agreement, there shall not have occurred any material adverse change, or any development involving a prospective material adverse change, in or affecting the business or properties of the Company or its subsidiaries, taken as a whole, whether or not arising in the ordinary course of business, which, in your reasonable judgment, makes it impractical to proceed with the -19- public offering or delivery of the Shares as contemplated hereby or to attempt to enforce contracts for the purchase of the Shares. (e) There shall have been furnished to you on the First Closing Date or the Second Closing Date, as the case may be: (i) An opinion of Secore & Waller, L.L.P., Dallas, Texas, counsel for the Company, addressed to you and dated the First Closing Date or the Second Closing Date, as the case may be, to the effect that: (1) Each of the Company and First Midlothian is validly existing as a corporation in good standing under the laws of the State of Texas with full corporate power and authority to own or lease its properties and conduct its business as described in the Prospectus; each of the Company and First Midlothian is a bank holding company duly registered with the Federal Reserve Board; and each of the Company and First Midlothian has been duly qualified to do business as a foreign corporation under the corporation law of, and is in good standing as such in, every jurisdiction where the ownership or leasing of property, or the conduct of its business, requires such qualification except where the failure so to qualify would not have a Material Adverse Effect. (2) Each Bank is a national bank duly chartered and organized by authority of the OCC, validly existing and in good standing under the laws of the United States of America. Each subsidiary of the Company or First Midlothian is validly existing as a corporation in good standing under the laws of its state of incorporation with full corporate power and authority to own or lease its properties and conduct its business as described in the Prospectus; and each subsidiary of its Company or First Midlothian has been duly qualified to do business as a foreign corporation under the corporation law of, and is in good standing as such in, every jurisdiction where the ownership or leasing of property, or the conduct of its business, requires such qualification except where the failure so to qualify would not have a Material Adverse Effect. (3) The Company has an authorized capitalization as set forth in the Prospectus and the Shares conform, in all material respects, to the description thereof contained in the Prospectus. (4) No consent, approval, authorization or other order of or filing with, any court, regulatory body, administrative agency or other -20- governmental body is legally required for the execution, delivery and performance of this Agreement by the Company, except as may be required under or by the 1933 Act, the Amex or the blue sky laws of the various jurisdictions. (5) Each of this Agreement and the Pricing Agreement have been duly and validly authorized and executed by the Company and constitutes a valid and binding obligation of the Company except only insofar as (i) such agreement may be subject to bankruptcy, insolvency, reorganization, moratorium or other laws relating to creditors' rights generally, (ii) the remedy of specific performance and injunctive and other equitable relief may be subject to equitable defenses, and (iii) such enforcement may be subject to any limitations under applicable federal securities laws relating to indemnification and contribution. (6) The Registration Statement has become effective under the 1933 Act, and, to the best knowledge of such counsel, no stop order suspending the effectiveness of the Registration Statement has been issued and no proceedings for that purpose have been instituted or are pending or contemplated by the Commission under the 1933 Act, and the Registration Statement (including the information deemed to be part of the Registration Statement at the time of effectiveness pursuant to Rule 430A(b), if applicable), the Prospectus and each amendment or supplement thereto (except for the financial statements and other statistical or financial data included therein as to which such counsel need express no opinion) comply as to form in all material respects with the requirements of the 1933 Act; and the Primary Shares to be issued to the Underwriter have been approved for listing on the Amex upon official notice of issuance. (7) There are no contracts or documents required to be described in the Registration Statement or Prospectus or to be filed as exhibits to the Registration Statement which are not described or filed, as required, and such contracts and documents as are summarized in the Registration Statement or Prospectus are fairly summarized in all material respects; and there are no statutes or regulations or any legal or governmental proceedings pending or, to the knowledge of such counsel, threatened, required to be described in the Prospectus which are not described as required. (8) All of the issued and outstanding shares of the Company's capital stock have been duly authorized, validly issued and are -21- fully paid and non-assessable and free of preemptive or other similar rights under the Texas Business Corporation Act, and to such counsel's knowledge there are no options, agreements, contracts or other rights in existence to acquire from the Company any shares of Common Stock, except as set forth in the Prospectus. Except as set forth in the Prospectus, to such counsel's knowledge there are no holders of the securities of the Company having rights to the registration thereof. The Company has no subsidiary which conducts business as a bank under the laws of the State of Texas or Federal law, other than the Banks. All of the capital stock of each subsidiary of the Company, other than the Banks, has been duly authorized, validly issued and is fully paid and non-assessable. All of the outstanding capital stock of each of the Banks has been duly authorized and validly issued and is fully paid and, subject to 12 U.S.C. Section 55 (1982), nonassessable. The Company, directly or indirectly, owns of record, free and clear of any liens, claims, encumbrances or rights of others, all of the issued and outstanding shares of each of its subsidiaries, except as described in the Prospectus. To such counsel's knowledge, there are no options, agreements, contracts or other rights in existence to purchase or acquire from the Company or its subsidiaries any issued and outstanding shares of such subsidiaries. (9) The Primary Shares to be sold by the Company pursuant to this Agreement and the Pricing Agreement have been duly authorized and, when issued and paid for in accordance with this Agreement and the Pricing Agreement, will be validly issued, fully paid and non- assessable; the holders of the Shares will not be subject to personal liability under the Texas Business Corporation Act by reason of being such holders; the Shares are not subject under the Texas Business Corporation Act to the preemptive rights of any shareholder of the Company. (10) This Agreement and the Pricing Agreement have been duly and validly authorized, executed and delivered by the Company. (11) The statements in the Prospectus under the captions "Regulation and Supervision" and "Description of Securities," insofar as they constitute conclusions of law, are correct in all material respects. (12) The execution, delivery and performance by the Company of this Agreement and the Pricing Agreement have been duly authorized by all necessary corporate action and do not and will not violate any provision of the Company's articles of incorporation (as amended) or bylaws (as amended) and do not and will not result in the breach of, or -22- violate, any of the terms or provisions of or constitute a default under, or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company or its subsidiaries under any material agreement, franchise, license, indenture, lease, mortgage, deed of trust, or other instrument known to such counsel to which the Company or any subsidiary is a party or by which the Company, any subsidiary or the property of any of them may be bound or affected, or, to such counsel's knowledge, any law, order, judgment, decree, rule or regulation applicable to the Company or any subsidiary of any government, governmental instrumentality, court or regulatory body, administrative agency or other governmental body having jurisdiction over the Company or any subsidiary or any of their respective properties, or any order of any court or governmental agency or other regulatory authority entered in any proceeding to which the Company or any subsidiary was or is now a party or by which it is bound. (13) There is no material legal proceeding pending or, to such counsel's knowledge, threatened against the Company except as disclosed in the Prospectus. (14) Neither the Company nor any of its subsidiaries is an "investment company" within the meaning of the Investment Company Act of 1940, as amended. (15) That certain Reorganization Agreement dated October 17, 1995 among First Midlothian, Midlothian Bank, the directors of Midlothian in their individual and representative capacities and the Company and the transactions contemplated thereby has been authorized by all necessary corporate action on the part of the Company, has been executed and delivered by the Company and the other parties thereto and constitutes a valid and binding obligation of the Company (assuming the due authorization, execution and delivery thereof by the other parties thereto) enforceable against the Company in accordance with its terms, except insofar as (i) such agreement may be subject to bankruptcy, insolvency, reorganization, moratorium or other laws relating to creditors' rights generally, and (ii) the remedy of specific performance and injunctive and other forms of equitable relief may be subject to equitable defenses and to the discretion of the court before which any proceeding thereafter may be brought. -23- In rendering such opinion, such counsel may rely, provided that the opinion shall state that you and they are entitled to so rely, as to factual matters on certificates of the officers and employees of, and accountants for, the Company. Such opinion may contain such other qualifications and assumptions as are reasonably acceptable to counsel for the Underwriter. In addition, counsel shall state that they have participated in conferences with officers and other representatives of the Company, representatives of the independent public accountants for the Company, and representatives of the Underwriter and its counsel, at which the contents of the Registration Statement, the Prospectus and related matters were discussed and, although such counsel is not passing upon, and does not assume any responsibility for, the accuracy, completeness or fairness of the statements contained in the Registration Statement or the Prospectus and has not made any independent check or verification thereof, on the basis of the foregoing (relying as to factual matters upon the statements of officers and other representatives of the Company), no facts have come to such counsel's attention that have led them to believe that the Registration Statement (other than financial statements, the notes thereto and related schedules and other financial, statistical and accounting data included therein or omitted therefrom, as to which such counsel need express no belief), as amended or supplemented, if applicable, at the time such Registration Statement or any post-effective amendment became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading (other than information omitted therefrom in reliance on Rule 430A under the 1933 Act), or that the Prospectus (other than financial statements, the notes thereto and related schedules and other financial, statistical and accounting data included therein or omitted therefrom, as to which such counsel need express no view) as amended or supplemented, if applicable, as of its date and the First Closing Date or the Second Closing Date, as applicable, contained an untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein not misleading in light of the circumstances under which they were made. (ii) Wyatt, Tarrant & Combs, Nashville, Tennessee, counsel to the Selling Shareholder, shall have furnished to you their written opinion, dated the First Closing Date or the Second Closing Date, as the case may be, to the effect that: -24- (1) The Selling Shareholder has valid and unencumbered title to the Shares being sold by the Selling Shareholder and has full, right, power and authority to sell, assign, transfer and deliver such Shares pursuant to this Agreement, and upon delivery of such Shares and payment therefor, the Underwriter will acquire valid and unencumbered title to the Shares purchased by it from the Selling Shareholder. (2) No consent, approval, authorization or order of, or filing with, any governmental agency or body or any court is required to be obtained or made by any Selling Shareholder for the consummation of the transactions contemplated by this Agreement or in connection with the sale of the Shares sold by the Selling Shareholder, except such as have been obtained and made under the Act and such as may be required under state securities laws. (3) The execution, delivery and performance of this Agreement and the consummation of the transactions therein contemplated will not result in a breach or violation of any of the terms and provisions of, or constitute a default under, any statute, any rule, regulation or order of any governmental agency or body or any court having jurisdiction over the Selling Shareholder or any of its properties, or any agreement or instrument to which the Selling Shareholder is a party or by which any Selling Shareholder is bound or to which any of the properties of any Selling Shareholder is subject, or the charter or by-laws of any Selling Shareholder. (4) This Agreement has been duly authorized, executed and delivered by the Selling Shareholder and constitutes a legal, valid and binding obligation of the Selling Shareholder enforceable against the Selling Shareholder in accordance with its terms, except insofar as (i) the remedy of specific performance and injunctions and other forms of equitable relief may be subject to equitable defenses and the discretion of the court before which any proceeding thereafter may be brought, and (ii) such enforcement may be subject to any limitations under applicable federal securities laws relating to indemnification and contribution. (5) The Custody Agreement has been duly executed and delivered by the Selling Shareholder and constitutes a legal, valid and binding obligation of the Selling Shareholder enforceable against the Selling Shareholder in accordance with its terms except insofar as the remedy of specific performance and injunctive and other forms of equitable relief may -25- be subject to equitable defenses and to the discretion of the court before which any proceeding thereafter may be brought. In rendering such opinion, such counsel may rely, provided that the opinion shall state that you and they are entitled to so rely, as to factual matters on certificates of the officers and employees of, the Selling Shareholder. Such opinion may contain such other qualifications and assumptions as are reasonably acceptable to counsel for the Underwriter. (iii) Such opinion or opinions of Bracewell & Patterson, L.L.P., counsel for the Underwriter, dated the First Closing Date or the Second Closing Date, as the case may be, to such matters as you may reasonably require. (iv) A certificate of the Company executed by the chief executive officer and the principal financial officer of the Company, dated the First Closing Date or the Second Closing Date, as the case may be, to the effect that: (1) the representations and warranties of the Company set forth in Section 2 of this Agreement are true and correct, in all material respects, as of the date of this Agreement and as of the First Closing Date or the Second Closing Date, as the case may be, and the Company has complied, in all material respects, with all the agreements and satisfied all the conditions on its part to be performed or satisfied at or prior to such Closing Date; and (2) the Commission has not issued an order preventing or suspending the use of the Prospectus or any preliminary prospectus filed as part of the Registration Statement or any amendment thereto; no stop order suspending the effectiveness of the Registration Statement has been issued; and to the best knowledge of the respective signers, no proceedings for that purpose have been instituted or are pending or contemplated under the 1933 Act. The delivery of the certificate provided for in this subsection shall be and constitute a representation and warranty of the Company as to the facts required in the immediately foregoing paragraphs (1) and (2) of this subsection to be set forth in said certificate. (v) A certificate of the Selling Shareholder executed by the Special Deputy Commissioner and Liquidator of the Company, dated the First Closing Date, to the effect that the representations and warranties of the Selling -26- Shareholder set forth in Section 3 of this Agreement are true and correct, in all material respects, as of the date of this Agreement and as of the First Closing Date, and the Selling Shareholder has complied, in all material respects, with all the agreements and satisfied all the conditions on its part to be performed or satisfied at or prior to the First Closing Date. The delivery of the certificate provided for in this subsection shall be and constitute a representation and warranty of the Selling Shareholder as to the facts required in this subsection to be set forth in said certificate. (vi) At the time the Pricing Agreement is executed and also on the First Closing Date and the Second Closing Date, as the case may be, there shall be delivered to you a letter addressed to you from Coopers & Lybrand LLP, independent accountants, the first one to be dated the date of the Pricing Agreement, the second one to be dated the First Closing Date and the third one (in the event of a second closing) to be dated the Second Closing Date, to the effect set forth in Exhibit B. (vii) Contemporaneously with the closing of the purchase and sale of the Shares on the First Closing Date, the transactions among the Company, First Midlothian, Midlothian Bank and the directors of Midlothian Bank described in the Prospectus under the caption "The Midlothian Bank Acquisition" shall have been consummated in the manner contemplated by the Prospectus and otherwise satisfactory to the Underwriter in its reasonable discretion, and the Underwriter shall have received the certificate of the President of the Company to such effect. (viii) The Underwriter shall have received a Lock-Up Letter from each executive officer and director of the Company. (ix) Such further certificates and documents as you may reasonably request. All such opinions, certificates, letters and documents shall be in compliance with the provisions hereof only if they are satisfactory to you and to Bracewell & Patterson, L.L.P., counsel for the Underwriter. The Company and the Selling Shareholder shall furnish you with such manually signed or conformed copies of such opinions, certificates, letters and documents as you reasonably request. If any condition to the Underwriter's obligations hereunder to be satisfied prior to or at the First Closing Date is not so satisfied, this Agreement at your election will terminate upon notification to the Company and the Selling Shareholder without liability on the part of the Underwriter, the Company or the Selling Shareholder, except for the expenses to be -27- paid or reimbursed by the Company and the Selling Shareholder pursuant to Sections 7 hereof and except to the extent provided in Section 9 hereof. SECTION 9. INDEMNIFICATION. (a) The Company agrees to indemnify and hold harmless the Underwriter and each person, if any, who controls the Underwriter within the meaning of the 1933 Act or the Exchange Act, and to indemnify and hold harmless the Selling Shareholder and each person, if any, who controls the Selling Shareholder within the meaning of the 1933 Act or the Exchange Act, from and against any and all losses, claims, damages, liabilities and expenses whatsoever (including but not limited to reasonable attorneys' fees and any and all expenses whatsoever incurred in investigating, preparing or defending against any litigation, commenced or threatened, or any claim whatsoever, any and all amounts paid in settlement of any claim or litigation), joint or several, to which they or any of them may become subject under the 1933 Act, the Exchange Act or otherwise, insofar as such losses, claims, damages, liabilities and expenses arise out of or are based upon any untrue statement or a material fact contained in any preliminary prospectus or the Registration Statement or the Prospectus or in any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, or arise out of or are based in whole or in part on any inaccuracy in the representations and warranties of the Company contained herein or any failure of the Company to perform its respective obligations hereunder or under law, except insofar as such losses, claims, damages, liabilities or expenses arise out of or are based upon any such untrue statement or omission or allegation thereof which has been made therein or omitted therefrom in reliance upon and in conformity with information furnished in writing to the Company by or on behalf of the Underwriter expressly for use therein; provided, however, that the indemnification contained in this paragraph with respect to any preliminary prospectus shall not inure to the benefit of the Underwriter (or of any person controlling the Underwriter) with respect to any action or claim arising from the sale of the Shares by the Underwriter brought by any person who purchased Shares from the Underwriter to the extent it is determined by a court of competent jurisdiction in a final non-appealable decision that (i) a copy of the Prospectus (as amended or supplemented if any amendment or supplements thereto shall have been furnished to the Underwriter prior to the written confirmation of the sale involved) shall not have been given or sent to such person by or on behalf of the Underwriter with or prior to the written confirmation of the sale involved and (ii) the untrue statement or omission of a material fact contained in such preliminary prospectus was corrected in the Prospectus (as amended or supplemented if amended or supplemented as aforesaid). In addition to its other obligations under this Section 9(a), the Company agrees that, as an interim measure during the pendency of any such claim, action, investigation, inquiry or other proceeding arising out of or based upon any statement or omission, or any alleged statement or omission, described in this Section 9(a), it will promptly reimburse the Underwriter and the Selling Shareholder for all reasonable legal expenses as they are -28- incurred in connection with investigating or defending such claim, action, investigation, inquiry or other proceeding. To the extent that any such interim reimbursement payment is held by a court of competent jurisdiction to have been improper, each recipient thereof will promptly return it to the Company. (b) The Selling Shareholder agrees to indemnify and hold harmless the Company, each of its officers and directors who sign the Registration Statement and each person, if any, controlling the Company within the meaning of the 1933 Act or the Exchange Act, and to indemnify and hold harmless the Underwriter and each person, if any, controlling the Underwriter within the meaning of the 1933 Act or the Exchange Act, to the same extent as the foregoing indemnity from the Company to the Underwriter and the Selling Shareholder, but only with respect to information relating to the Selling Shareholder furnished in writing to the Company or the Underwriter by or on behalf of the Selling Shareholder expressly for use in the Registration Statement, the Prospectus, any preliminary prospectus, or any amendment thereof or supplement thereto. (c) The Underwriter agrees to indemnify and hold harmless the Company, its directors, its officers who sign the Registration Statement and any person controlling the Company within the meaning of the 1933 Act and the Exchange Act, and to indemnify and hold harmless the Selling Shareholder and each person, if any, controlling the Selling Shareholder within the meaning of the 1933 Act and the Exchange Act, to the same extent as the foregoing indemnity from the Company to the Underwriter and the Selling Shareholder, but only with respect to information relating to the Underwriter furnished in writing to the Company by or on behalf of the Underwriter expressly for use in the Registration Statement, the Prospectus or any preliminary prospectus, or any amendment thereof or supplement thereto. (d) If any action or claim shall be brought against any indemnified party under this Section 9, such indemnified party will, if a claim in respect thereof is to be made against an indemnifying party under this Section 9, promptly notify the indemnifying party in writing of the commencement thereof. No indemnification shall be available to any party who shall fail to give notice as provided in this Section 9(d) if the party to whom notice was not given was unaware of the proceeding to which such notice would have related and was prejudiced by the failure to give such notice, but otherwise the omission so to notify the indemnifying party will not relieve it from any liability that it may have to an indemnified party under this Section 9. In case any such action is brought against an indemnified party, and it notifies the indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein, and to the extent that it may elect by written notice delivered to the indemnified party promptly after receiving the aforesaid notice from such indemnified party, to assume the defense thereof, with counsel reasonably satisfactory to such indemnified party. Upon receipt of notice from the indemnifying party to such -29- indemnified party of its election to assume the defense of such action and approval by the indemnified party of counsel, the indemnifying party will not be liable to such indemnified party under Section 9 for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof unless (i) the indemnifying party has agreed in writing to pay such fees and expenses, (ii) the indemnifying party shall not have employed counsel satisfactory to the indemnified party to represent the indemnified party within a reasonable time after notice of commencement of the action or (iii) the named parties to any such action (including any impleaded party) include such indemnified party and the indemnifying party and such indemnified party shall have been advised in writing by counsel having experience in securities litigation that there may be one or more legal defenses available to it which are different from or additional to those available to the indemnifying party (in which case if such indemnified party notifies the indemnifying party, the indemnifying party shall, in connection with any one such action or separate but substantially similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances, be liable for the reasonable fees and expenses of not more than one separate firm of attorneys for all such indemnified parties) and which, in the opinion of such counsel, would make it impractical to have common representation. The indemnifying party shall not be liable for any settlement of any such action effected without its written consent, but if settled with its written consent, or if there shall be a final judgment for the plaintiff in any such action and the time for filing all appeals has expired, the indemnifying party agrees to indemnify and hold harmless any indemnified party and any such controlling person from and against any loss or liability by reason of such settlement or judgment. (e) (i) If the indemnification provided for in this Section 9 is unavailable as a matter of law to an indemnified party in respect of any losses, claims, damages, liabilities or expenses referred to therein, then the indemnifying party, in lieu of indemnifying such indemnified party thereunder, shall contribute to the amount paid or payable by the indemnified party as a result of such losses, claims, damages, liabilities or expenses (A) in such proportion as is appropriate to reflect the relative benefits received by the Company, the Selling Shareholder and the Underwriter from the offering of the Shares or (B) if the allocation provided by clause (A) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (A) above but also the relative fault of the Company, the Selling Shareholder and of the Underwriter in connection with the statements or omissions which resulted in such losses, claims, damages, liabilities or expenses, as well as any other relevant equitable considerations. The respective relative benefits received by the Company, the Selling Shareholder and the Underwriter shall be deemed to be in the same proportion, in the case of the Company and the Selling Shareholder, as the total price paid to the Company or the Selling Shareholder, as the case may be, for the Shares by the Underwriter (net of underwriting discounts and commissions but before deducting expenses), and, in the case of the Underwriter, as the underwriting commissions received by it, bears to the total of such -30- amounts paid to the Company and received by the Underwriter as underwriting commissions in each case as contemplated by the Prospectus. The relative fault of the Company, the Selling Shareholder and of the Underwriter shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company, the Selling Shareholder or by the Underwriter and the party's relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omissions. (ii) The Company, the Selling Shareholder and the Underwriter agree that it would not be just and equitable if contribution pursuant to this Section 9(e) were determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to in subsection (e)(i). The amount paid or payable by an indemnified party as a result of the losses, claims, damages, liabilities and expenses referred to in subsection (e)(i) shall be deemed to include, subject to the limitations set forth in this Section 9(e), any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this Section 9(e), the Underwriter shall not be required to contribute any amount in excess of the amount of the total underwriting commissions received by the Underwriter in connection with the Shares underwritten by it and distributed to the public. No person guilty of fraudulent misrepresentation (within the meaning of Section 11 (f) of the 1933 Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. (f) The indemnity and contribution agreements contained in this Section 9 and the representations and warranties of the Company set forth in this Agreement shall remain operative and in full force and effect, regardless of (i) any investigation made by or on behalf of the Underwriter or any person controlling the Underwriter, the Selling Shareholder, the Company or its directors or officers (or any person controlling any such person), (ii) acceptance of any Shares and payment therefor or hereunder and (iii) any termination of this Agreement. A successor or assign of the Underwriter, the Selling Shareholder, the Company or its directors or officers and their legal and personal representatives (or of any person controlling an Underwriter or the Company) shall be entitled to the benefits of the indemnity, contribution and reimbursement agreements contained in this Section 9. SECTION 10. EFFECTIVE DATE. This Agreement shall become effective immediately as to Sections 7, 9 and 11 and as to all other provisions upon execution and delivery of the Pricing Agreement. SECTION 11. TERMINATION. Without limiting the right to terminate this Agreement pursuant to any other provision hereof, this Agreement may also be terminated by you in -31- your absolute discretion, without liability on your part to the Company or to the Selling Shareholder, by notice given to the Company and the Selling Shareholder, if prior to the First Closing Date or, with respect to the Additional Shares, on or prior to any later date on which the Additional Shares are to be purchased, as the case may be, (i) there has been, since the date of this Agreement or since the respective dates as of which information is given in the Prospectus any material adverse change in the condition, financial or otherwise, or the earnings, business affairs or business prospects of the Company and its subsidiaries, or First Midlothian and its subsidiaries, considered as a whole, whether or not arising in the ordinary course of business; or (ii) trading in securities generally on the New York Stock Exchange, the American Stock Exchange or the National Association of Securities Dealers Automated Quotation System shall have been suspended, or if there is a significant decline in the value of securities generally on such exchanges or such market, or minimum or maximum prices for trading shall have been fixed, or maximum ranges for prices for securities generally shall have been required on either of such exchanges or on such market, by the exchanges, market or by order of the Commission or any other governmental authority having jurisdiction; or (iii) a general moratorium on savings bank, savings and loan association or commercial banking activities in the United States or in New York or Texas shall have been declared by either Federal or state authorities; or (iv) there shall have occurred any outbreak or escalation of hostilities or other international or domestic calamity, crisis or change in political, financial or economic conditions the effect of which on the financial markets of the United States is such as to make it, in your judgment, impracticable or inadvisable to market the Shares or to enforce contracts for the purchase of Shares. Notice of such cancellation shall be given to the Company and the Selling Shareholder by telegraph, telephone or facsimile but shall be subsequently confirmed by letter. SECTION 12. REPRESENTATIONS AND INDEMNITIES TO SURVIVE DELIVERY. The respective indemnities, agreements, representations, warranties and other statements of the Company, the Selling Shareholder and the Underwriter set forth in or made pursuant to this Agreement will remain in full force and effect, regardless of any investigation made by or on behalf of the Underwriter, the Selling Shareholder or the Company or any of its or their partners, officers or directors or any controlling person, and will survive delivery of and payment for the Shares sold hereunder. SECTION 13. NOTICES. All communications hereunder will be in writing and, if sent to the Underwriter will be mailed, delivered or telegraphed and confirmed to Hoefer & Arnett Incorporated, 353 Sacramento Street, 10th Floor, San Francisco, California 94111, with a copy to Bracewell & Patterson, L.L.P., 711 Louisiana St., Suite 2900, Houston, Texas 77002, Attention: John R. Brantley; if sent to the Company will be mailed, delivered or telegraphed and confirmed to the Company at its corporate headquarters with a copy to Secore & Waller, L.L.P., 13355 Noel Road, LB 75, Dallas, Texas 75240-6657, Attention: Dan Waller; if sent to the Selling Shareholder will be mailed, delivered or telegraphed and -32- confirmed to the Selling Shareholder c/o Tennessee Receiver's Office, 7000 Executive Center Drive, The Waverly Building, Suite 200, Brentwood, Tennessee 37027, with a copy to Wyatt, Tarrant & Combs, 1500 Nashville City Center, Nashville, Tennessee 37219, Attention: Daniel B. Brown. SECTION 14. SUCCESSORS. This Agreement and the Pricing Agreement will inure to the benefit of and be binding upon the parties hereto and their respective successors, personal representative and assigns, and to the benefit of the officers and directors and controlling persons referred to in Section 9, and no other person will have any right or obligation hereunder. The term "successors" shall not include any purchaser of the Shares as such from the Underwriter merely by reason of such purchase. SECTION 15. PARTIAL UNENFORCEABILITY. If any section, paragraph or provision of this Agreement is for any reason determined to be invalid or unenforceable, such determination shall not affect the validity or enforceability of any other section, paragraph or provision hereof. SECTION 16. APPLICABLE LAW. This Agreement and the Pricing Agreement shall be governed by and construed in accordance with the laws of the State of California. [THE REMAINDER OF THIS PAGE INTENTIONALLY LEFT BLANK.] -33- If the foregoing is in accordance with your understanding of our agreement, kindly sign and return to us the enclosed duplicates hereof, whereupon it will become a binding agreement among the Company, the Selling Shareholder and the Underwriter, all in accordance with its terms. Very truly yours, SURETY CAPITAL CORPORATION By:_______________________________ C. Jack Bean Chief Executive Officer ANCHORAGE FIRE AND CASUALTY INSURANCE COMPANY, IN LIQUIDATION By: Elaine A. McReynolds, Commissioner of Commerce, State of Tennessee, as Conservator By:_______________________________ Jeanne Barnes Bryant, Special Deputy Commissioner and Liquidator The foregoing Agreement is hereby confirmed and accepted as of the date first above written. HOEFER & ARNETT INCORPORATED By:_______________________________ Greg H. Madding Partner -34- -----END PRIVACY-ENHANCED MESSAGE-----